EXAMINING THE MARKET POWER AND 

IMPACT OF PROXY ADVISORY FIRMS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS AND 

GOVERNMENT SPONSORED ENTERPRISES 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

JUNE 5, 2013 

Printed for the use of the Committee on Financial Services 

Serial No. 113–27 

( 

EXAMINING THE MARKET POWER AND IMPACT OF PROXY ADVISORY FIRMS 

U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

81–762 PDF 2013

EXAMINING THE MARKET POWER AND 

IMPACT OF PROXY ADVISORY FIRMS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS AND 

GOVERNMENT SPONSORED ENTERPRISES 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

JUNE 5, 2013 

Printed for the use of the Committee on Financial Services 

Serial No. 113–27 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

GARY G. MILLER, California, Vice Chairman 

SPENCER BACHUS, Alabama, Chairman 

Emeritus 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

ROBERT HURT, Virginia 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

TOM COTTON, Arkansas 

KEITH J. ROTHFUS, Pennsylvania 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS AND GOVERNMENT SPONSORED ENTERPRISES

SCOTT GARRETT, New Jersey, Chairman 

ROBERT HURT, Virginia, Vice Chairman 

SPENCER BACHUS, Alabama 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RANDY NEUGEBAUER, Texas 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

LYNN A. WESTMORELAND, Georgia 

BILL HUIZENGA, Michigan 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ANN WAGNER, Missouri 

CAROLYN B. MALONEY, New York, 

Ranking Member 

BRAD SHERMAN, California 

RUBE ́ N HINOJOSA, Texas 

STEPHEN F. LYNCH, Massachusetts 

GWEN MOORE, Wisconsin 

ED PERLMUTTER, Colorado 

DAVID SCOTT, Georgia 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

KEITH ELLISON, Minnesota 

MELVIN L. WATT, North Carolina 

BILL FOSTER, Illinois 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

DANIEL T. KILDEE, Michigan 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

June 5, 2013 ...................................................................................................... 1 

Appendix: 

June 5, 2013 ...................................................................................................... 37 

WITNESSES 

WEDNESDAY, JUNE 5, 2013 

Bartl, Timothy J., President, Center on Executive Compensation ...................... 8 

Holch, Niels, Executive Director, Shareholder Communications Coalition ........ 10 

McCauley, Michael P., Senior Officer, Investment Programs and Governance, 

Florida State Board of Administration (SBA) .................................................... 11 

Morgan, Jeffrey D., President and Chief Executive Officer, National Investor 

Relations Institute (NIRI) ................................................................................... 13 

Pitt, Hon. Harvey L., Founder and Chief Executive Officer, Kalorama Partners, LLC, on behalf of the U.S. Chamber of Commerce .................................. 7 

Stuckey, Darla C., Senior Vice President, Policy & Advocacy, Society of Corporate Secretaries and Governance Professionals ............................................. 15 

Turner, Lynn E., Managing Director, LitiNomics ................................................. 17 

APPENDIX 

Prepared statements: 

Bartl, Timothy J. .............................................................................................. 38 

Holch, Niels ....................................................................................................... 150 

McCauley, Michael P. ....................................................................................... 162 

Morgan, Jeffrey D. ............................................................................................ 169 

Pitt, Hon. Harvey L. ......................................................................................... 182 

Stuckey, Darla C. ............................................................................................. 222 

Turner, Lynn E. ................................................................................................ 345 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Garrett, Hon. Scott: 

Written statement of Gary Retelny, President, Institutional Shareholder 

Services Inc. .................................................................................................. 357 

Letter from Susan Ferris Wyderko, President and CEO, the Mutual Fund 

Directors Forum, dated June 4, 2013 .......................................................... 374 

Moore, Hon. Gwen: 

Written statement of Sean Egan, Chief Executive Officer, Egan-Jones 

Rating Company ........................................................................................... 375 

Sherman, Hon. Brad: 

Written statement of Ann Yerger, Executive Director, the Council of 

Institutional Investors .................................................................................. 376 

Waters, Hon. Maxine: 

Written statement of Anne Simpson, Senior Portfolio Manager, Investments, and Director of Global Governance, the California Public Employees’ Retirement System ......................................................................... 395 

Written statement of Katherine H. Rabin, Chief Executive Officer, Glass, 

Lewis & Co. ................................................................................................... 402 

(1) 

EXAMINING THE MARKET POWER AND 

IMPACT OF PROXY ADVISORY FIRMS 

Wednesday, June 5, 2013 

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON CAPITAL MARKETS AND

GOVERNMENT SPONSORED ENTERPRISES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The subcommittee met, pursuant to notice, at 10:01 a.m., in room 

2128, Rayburn House Office Building, Hon. Scott Garrett [chairman of the subcommittee] presiding. 

Members present: Representatives Garrett, Hurt, Royce, 

Bachmann, Grimm, Stivers, Fincher, Mulvaney, Hultgren, Wagner; 

Sherman, Moore, Scott, Himes, Peters, Sewell, and Kildee. 

Ex officio present: Representatives Hensarling and Waters. 

Chairman GARRETT. Greetings. Good morning. This hearing of 

the Subcommittee on Capital Markets and Government Sponsored 

Enterprises is hereby called to order. 

Today’s hearing is entitled, ‘‘Examining the Market Power and 

Impact of Proxy Advisory Firms.’’ I thank our extended panel who 

are here with us here this morning, and I thank the Members from 

both sides, as well. 

We will begin, as we always do, with opening statements, and 

then look to the panel for your wisdom and input. 

So at this point, I will yield myself about 9 minutes. I am not 

sure I will use all of it. 

With the 2013 proxy season currently in full swing, today’s hearing examines the market power impact of proxy advisory firms and, 

more broadly, whether the proxy system is working for U.S. companies and their shareholders. 

Every year, investors vote over 600 billion shares through the 

proxy system to elect boards of directors and take other corporate 

actions, as well. Therefore, an accurate, efficient, and transparent 

proxy voting system is important to ensuring that our capital markets remain competitive. 

While proxy voting can play an important role in promoting good 

corporate governance and enhancing shareholder values, the current system for distributing proxy materials and voting shares has 

become so complicated that few outside of the proxy process understand how it actually works, including most retail investors, I 

would guess. 

In addition, corporate proxy disclosures have become more voluminous and complex than ever, and the Dodd-Frank Act and SEC 

rules have significantly expanded the types of issues now subject 

2 

to shareholder vote. As a result, many institutional investors and 

investment advisory firms have come to rely exclusively on proxy 

advisory firms to help them determine how to vote their clients’ 

shares on literally thousands of proxy questions companies pose 

each and every year. And much like the overreliance on credit rating agencies during the financial crisis, the rise of proxy advisory 

firms over the last decade is attributable in large part to the unintended consequences of government regulation. 

Back in 2003, the SEC issued rules requiring mutual funds and 

their investment advisors to construct policies and procedures reasonably designed to ensure that proxies are voted in their clients’ 

best interest. The next year, however, the SEC staff—rather than 

the Commission itself—interpreted the rules in a manner that now 

allows mutual funds and investment advisors to effectively 

outsource their fiduciary obligation when voting their clients’ proxies to supposedly independent proxy advisory firms. 

What is the result? Well, as a result of the SEC’s actions, proxy 

advisory firms now wield an enormous amount of influence over 

shareholder voting here in the United States. Two firms in particular you all know—Institutional Shareholder Services (ISS), and 

Glass, Lewis & Company—account for around 97 percent of the 

proxy advisory industry. 

Together, these two firms alone are reported to provide voting 

recommendations to clients controlling between 25 and 50 percent 

of the typical mid-cap or large-cap company shares. Studies indicate that ISS and Glass Lewis are able to sway at least 20 to 40 

percent of shareholder votes, particularly in high-profile corporate 

elections. 

Despite their outside influence, however, proxy advisory firms 

have no duty to make voting recommendations in the best interest 

of the shareholders, and they have no financial interest in the companies about which they provide voting advice. It should come as 

no surprise, then, that proxy advisory firms often make voting recommendations based on one-size-fits-all policies and checklists that 

fail to take into consideration how voting recommendations affect 

the actual shareholder value. 

In fact, proxy advisory firms have increasingly teamed up with 

others, such as unions and other activist shareholders, to push a 

variety of social or political or environmental proposals that are 

generally immaterial to investors and often reduce shareholder 

value. For example, one recent study found that the stock market 

reaction to say-on-pay voting recommendations supported by proxy 

advisors has actually been statistically negative. 

So by exploiting the proxy system to push special interest agendas, proxy advisory firms and activist shareholders have increased 

the cost of doing business for many public companies and 

disincentivized private companies from going public—all without a 

corresponding benefit to the investor returns. 

Questions have been raised regarding potential conflicts of interest that proxy advisory firms may face when making voting recommendations, for example, as I alluded to a moment ago, activist 

shareholders—now some of ISS’ and Glass Lewis’ biggest clients— 

which increases the risk that these two firms will favor special inVerDate Nov 24 2008 17:50 Nov 21, 2013 Jkt 081762 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 K:\DOCS\HBA156.160 TERRI
3 

terest proposals over those that actually increase or enhance the 

shareholder values. 

With all that said, while there may be concerns regarding the 

manner in which proxy advisory firms operate, proxy advisory 

firms still serve a valuable role, helping to promote good corporate 

governance. These firms should not, however, be enshrined as the 

sole corporate government standard-setters. 

And finally, to the extent that regulatory changes to the proxy 

voting system are necessary, these changes should be aimed at improving the transparency and efficiency of proxy voting and, most 

importantly, enhancing shareholder value. That is, after all, the 

point of good corporate governance. 

With that, I will yield back my remaining time, and I now yield 

5 minutes to the gentleman from California. 

Mr. SHERMAN. Thank you, Mr. Chairman. 

I want to thank the ranking member of the full committee for 

asking me to sit in for the ranking member of this subcommittee, 

who is attending the funeral of our esteemed colleague, Senator 

Lautenberg; she was a close personal friend of the Senator. 

We once had a competition in this world between capitalism and 

communism. The new competition is between free market capitalism on the one hand and crony capitalism on the other. 

The advocates of crony capitalism say that boards should be in 

total control of their corporations, a small group of people should 

control hundreds of billions of dollars, and shareholders should be 

frozen out of the decision-making process and given as little information as possible, as well as be deprived of any advice that would 

help them question the inside management. 

Those who believe in free market capitalism believe that shareholders should be in control of the corporation and they need information, advice, voting, and freedom from frivolous lawsuits. Yet 

those trying to protect inside power have denied them all of those 

things. 

As to information, we are told that shareholders can’t know 

about blood diamonds. They can’t know about secret political contributions because they are crazy if they want to make their investment decisions or their proxy decisions based on those decisions. 

Investors are not only told that they will be deprived of the information to make the decision; they are told they are crazy for even 

wanting to make that decision. 

This hearing is about depriving them of the advice. No one in the 

corporate world has tried to deprive pension plans and investors of 

all kinds of advice. 

As a matter of fact, I have never met somebody on Wall Street 

who wasn’t talking to me about how to sell advice to CalPERS. Yet 

in this one circumstance, all of a sudden they should not be allowed 

to get the advice they want, as if these are babes in the woods 

rather than the epitome of sophisticated investors. 

Then, we see a corporate world that has for many decades united 

behind the lowest common denominator of shareholder rights and 

corporate law. The rule is that whatever State can have the most 

pro-management, anti-shareholder corporate law will attract—will 

become the home domicile of major corporations. 

4 

If we cared about shareholders we should be setting the highest 

possible corporate standards for all—and shareholder rights for all 

publicly traded companies instead of saying, well, will Delaware or 

Nevada be the home of those corporations trying to institutionalize 

crony capitalism? 

Finally—and this is truly bizarre—the corporate world formed an 

alliance with plaintiffs’ trial lawyers to try to terrorize or prevent 

pension plans from divesting from Iran and use their corporate 

power in this very committee to hold up until a few years ago a 

bill that simply allowed pension plans to divest from those companies investing in Iran, because depriving shareholders of their right 

to divest and thereby influence management was thought to be an 

intrusion on the power of boards. 

It is about time for this committee to come out on the side of free 

market capitalism, of making sure that shareholders are given the 

information shareholders want, not called crazy because they care 

about jobs, the environment, preventing terrorism, or preventing 

secret political contributions. It is time that those investors get the 

advice. It is time that they have all the protections that a welldrafted corporate statute can provide. 

Instead, we are here focusing on the tiny bit of Wall Street advisors that habitually question inside management. That is not the 

role of this committee. 

I know it is easier to protect those who currently control corporations and therefore have power here in Washington, but those of 

us who believe in free market capitalism should be protecting 

shareholder rights, and that includes shareholders being able to get 

the advice they want. And no one here is for depriving them of any 

other kind of advice except to crack down on those who advise 

them on how to cast their votes to assure that we have jobs, open 

elections, and try to do something about Iran and other sources of 

terrorism. 

With that, I yield back. 

Chairman GARRETT. I am very pleased to hear that the gentleman from California is all about free market capitalism, and I 

look forward to the hearing today when we look to provide that 

through transparency and the ending of conflict of interests with 

regard to proxy advisors. 

Mr. SHERMAN. Mr. Chairman, I would like unanimous consent to 

enter into the record the statement of the Council of Institutional 

Investors. 

Chairman GARRETT. Without objection, it is so ordered. 

And I also look forward to the gentleman working with us outside of this issue to end crony capitalism and realign for free market capitalism and GSE reform, as well, so we can be on the same 

page on these things. 

With that, I yield to the gentleman from Virginia for 2 minutes. 

Mr. HURT. Thank you, Mr. Chairman. 

Mr. Chairman, thank you for holding today’s subcommittee hearing to examine the market power and impact of proxy advisory 

firms. As proxy advisory firms continue to have an increasingly 

powerful role in corporate governance, it is important that this 

committee conduct the proper oversight to ensure that these entiVerDate Nov 24 2008 17:50 Nov 21, 2013 Jkt 081762 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 K:\DOCS\HBA156.160 TERRI
5 

ties are working within the appropriate framework that leads to 

best practices in corporate governance. 

As an enormous market share is controlled by two proxy advisory 

firms, there must be sufficient transparency and accountability. A 

lack of these critical elements could lead to poor decisions that neither promote good corporate governance nor increase shareholder 

value. 

Additionally, as the SEC has acknowledged, conflicts of interest 

may arise when proxy advisory firms both provide voting recommendations for shareholder votes and simultaneously offer consulting services to the same company. An appropriate level of oversight, transparency, and accountability will ensure that that investors will be protected and it will strengthen corporate governance. 

I would like to thank our distinguished witnesses for appearing 

today before our subcommittee. I look forward to hearing your testimony. 

Thank you, Mr. Chairman. I yield back the balance of my time. 

Chairman GARRETT. The gentleman yields back the balance of 

his time—an extra 1 minute. 

And with that, we look to Mr. Scott for 3 minutes. 

Mr. SCOTT. Thank you very much. 

This is, indeed, an important, important hearing. Two issues certainly matter, I think, very much here: there are reasons why we 

have Dodd-Frank; and there are reasons why we have responded. 

From Enron to WorldCom to the 2008 financial crisis to the failure 

of MF Global, there are numerous examples—notable examples— 

of failures in corporate governance in recent years. 

And I am interested in finding out why only two companies handle 97 percent of this market. I think we need to get a good answer 

to that. Maybe there is a really good answer for it. But certainly, 

it is a very important question. 

With the 2013 proxy season under way, this hearing is quite 

timely, if not overdue. Proxy votes are currently taking place by institutional investors who typically own securities positions in a 

large number of public companies. These votes taking place are on 

matters such as director elections, consideration of management 

and shareholder proposals, and are also relevant to many of the delineated goals, as I stated before, of Dodd-Frank in response to the 

financial crisis. 

These can include issues such as: say on pay—which is very important—which is a nonbinding vote on executive compensation 

practices required under Dodd-Frank; splitting the role of CEO and 

chairman of the board at a public company; issues regarding employee nondiscrimination policies; or other corporate responsibility 

measures, including environmental practices. 

We must also recognize the possibility of, indeed, conflicts of interest, especially in a market as highly concentrated as proxy advisory, with the two largest firms, again as I said, dominating as 

much as 97 percent of that market—ISS and Glass Lewis. 

As I said, this is a great concern. Some proxy advisory firms also 

provide consulting services to issuers on corporate governance or 

executive compensation. A 2010 SEC concept release also noted the 

potential of conflicts of interests of such firms and the criticism 

with regards to lack of accuracy and transparency in firms formuVerDate Nov 24 2008 17:50 Nov 21, 2013 Jkt 081762 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 K:\DOCS\HBA156.160 TERRI
6 

lating voting recommendation. Yet, the SEC has not taken further 

action on this. 

So as we go forward to address the many regulatory issues raised 

by the directory of Dodd-Frank, we must balance concerns on behalf of the consumer, the user, our constituents, with the concerns 

raised by America’s public companies, many of whom also are run 

by our constituents and have stakes in our communities. What policies, for example, or procedures do proxy advisory firms use, if any, 

to ensure that their recommendations are independent and are not 

influenced by any consulting fees that they receive from issuers? 

I think the American public is very interested in this issue today, 

and I look forward to getting some very good answers to these 

questions that I have raised. 

Thank you, Mr. Chairman. 

Chairman GARRETT. The gentleman yields back. Actually, he 

doesn’t yield back; he went over. 

Is there anyone else? 

Mr. SCOTT. Thank you very much and I do yield— 

Chairman GARRETT. Ms. Moore is recognized for 2 minutes. 

Ms. MOORE. Thank you so much, Mr. Chairman and Mr. Ranking Member, for holding this hearing. I am eager to hear from our 

witnesses on proxy advisory firms, especially the increasingly important role they play in concentration in the industry. 

I want to discuss proxy access more conceptually and restate my 

support for Section 971 of Dodd-Frank. This is an area that has 

elicited considerable academic work and debate. 

Speaking to the Practicing Law Institute in 2009, then-SEC 

Chairman Schapiro said of shareholder access, ‘‘Corporate governance, after all, is about maintaining an appropriate level of accountability to shareholders by directors whom shareholders elect, 

and by managers who directors elect.’’ 

Chairman Schapiro went on regarding the election of board of directors, ‘‘I believe that the most effective means of promoting accountability in corporations is to make shareholders’ votes both 

meaningful and fully exercised. However, in most cases today 

shareholders have no choice in whom to vote for.’’ 

Congress agreed, and included Section 971 in Dodd-Frank. The 

State of Wisconsin Investment Board (SWIB) simply states that 

SWIB encourages companies to ‘‘establish reasonable conditions 

and procedures for shareholders to nominate director candidates to 

the company’s proxy and ballot.’’ I agree with that. 

One argument of opponents of Section 971-type proxy rules is 

that high-quality directors may be less willing to serve on boards 

if they face competition from shareholder-sponsored candidates. It 

is a silly and offensive argument. 

In an age when we tell college kids that they have to compete 

globally to get a job in corporations, and tell workers that they 

have to compete to keep their jobs in these corporations, why 

should directors of the corporations mysteriously be shielded from 

competition, especially from challenges from the shareholders they 

should serve? To hear some people tell it, Section 971 aids barbarians at the gate. In reality, it is a measured proposal to enhance 

corporate governance and accountability. 

And I yield back. 

7 

Chairman GARRETT. The gentlelady yields back. 

We now turn to the panel. And again, I welcome the entire panel. 

Some of you have been here before. For those who have not, you 

will all be recognized for 5 minutes, and the little lights in front 

of you will be green when you begin; yellow at one minute remaining; and red when your time us up. 

Also, your entire written statements will be made a part of the 

record, so we will look to you to summarize in your 5 minutes. 

So with that, again, I welcome the panel. And we will turn first 

to Mr. Pitt representing the U.S. Chamber of Commerce. 

Welcome to the panel. You are recognized for 5 minutes. 

STATEMENT OF THE HONORABLE HARVEY L. PITT, FOUNDER 

AND CHIEF EXECUTIVE OFFICER, KALORAMA PARTNERS, 

LLC, ON BEHALF OF THE U.S. CHAMBER OF COMMERCE 

Mr. PITT. Thank you, Mr. Chairman. It is a pleasure to be back 

here. 

Chairman Garrett, Representative Sherman, and members of the 

subcommittee, I am pleased to participate in these important hearings representing the U.S. Chamber of Commerce to discuss the extensive but unfettered influence that proxy advisory firms currently 

wield over corporate governance in the United States. 

As you have requested, I will not repeat the Chamber’s detailed 

written statement. Instead, I would like to briefly highlight 5 

points for your consideration. 

First, effective and transparent corporate governance systems 

that encourage meaningful shareholder communications are critical 

if public companies are to thrive. Informed and transparent proxy 

advice can promote effective corporate governance, but only if 

transparency exists throughout the proxy advisory process, and the 

advice provided directly correlates to and is solely motivated by advancing investors’ economic interests. Sadly, these two essential 

components of proxy advice have been lacking for some time. 

Second, as has already been observed, two firms—ISS and Glass 

Lewis—control 97 percent of the proxy advisory business and dominate the industry. Together, they effectively can influence nearly 

40 percent of the votes cast on corporate proxy issues, making 

them de facto arbiters of U.S. corporate governance. 

Third, these firms advocate governance standards to U.S. public 

companies but they do not practice what they preach. Serious conflicts permeate their activities, posing glaring hazards to shareholder interests. They are powerful but unregulated and they cavalierly refuse to formulate and follow ethical standards of their own, 

render their advice transparently, accept accountability for advocated standards, and assume responsibility to avoid factual errors 

and shoulder the burden to rectify the mistakes that they make. 

This lack of an operable framework for those exercising such a 

significant impact on our economic growth is wholly unprecedented 

in our society. Indeed, 2 weeks ago ISS settled serious SEC charges 

stemming from its failure to establish and enforce appropriate written policies. 

Fourth, significant economic consequences flow from proxy advisory firms’ unfettered power and lack of fidelity to important ethical and fiduciary precepts, something that has been recognized 

8 

both here and abroad. Although U.S. regulators have not fulfilled 

promises to address these issues, Canadian and European regulators, among others, are speaking out. 

Fifth, the answer to these concerns is not more regulation, but 

rather a collaborative public-private effort to identify core principles and best practices for the proxy advisory industry. In March, 

the Chamber published best practices and core principles which 

provides a crucial foundation for successfully delineating standards 

for the industry to embrace and follow. 

What is essential is for responsible voices—this subcommittee, 

the SEC, institutional investors, public companies, and proxy advisory firms—to lend support to the effort to promulgate and apply 

effective standards. 

Mr. Chairman, members of the subcommittee, it is my hope and 

strong recommendation that these hearings result in a serious commitment to achieve those goals. Thank you. 

[The prepared statement of Mr. Pitt can be found on page 182 

of the appendix.] 

Chairman GARRETT. And I thank you for your testimony. 

Next, from the Center on Executive Compensation, Mr. Bartl. 

STATEMENT OF TIMOTHY J. BARTL, PRESIDENT, CENTER ON 

EXECUTIVE COMPENSATION 

Mr. BARTL. Thank you, Mr. Chairman. 

Chairman Garrett, Representative Sherman, and members of the 

subcommittee, my name is Tim Bartl, and on behalf of the Center 

on Executive Compensation, I am pleased to present our views on 

this very important topic. My comments today are based in part on 

our paper, ‘‘A Call for Change in the Proxy Advisory Industry Status Quo,’’ and I would ask that a copy of that be submitted for the 

record. 

Chairman GARRETT. Without objection it is so ordered. 

Mr. BARTL. By way of background, the Center is a research and 

advocacy organization. We are a division of HR Policy Association, 

that represents the senior HR officers of over 340 large companies, 

and the Center’s subscribing members are across industry group of 

the association. 

Mr. Chairman, today I would like to focus on four points, if I 

may: the role of proxy advisory firms; their influence over company 

votes and practices; the impact, as Chairman Pitt talked about, of 

conflicts of interest and inaccuracies; and an example of the importance of oversight, both regulatory and legislative, in procuring 

some of the issues changes we are talking about today. 

As you have heard both from members of the subcommittee and 

from Chairman Pitt, proxy advisors fill an important role regarding 

helping institutional investors fulfill their proxy voting duties, but 

the speed with which the advisors must analyze proxies leads to a 

check-the-box mentality driven in part by the desire to present investors with a uniform, condensed version of corporate pay disclosures, even though pay programs are individualized, complex, and 

lengthy. This can lead to errors, inaccuracies, or questionable characterizations. 

And in part, the irony is that the regulatory regime effectively 

makes each issuer responsible, at least in part, for ensuring the acVerDate Nov 24 2008 17:50 Nov 21, 2013 Jkt 081762 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 K:\DOCS\HBA156.160 TERRI
9 

curacy of its proxy advisory firm reports even though the advisors 

are the experts. This calls into question the legitimacy of the current model. 

So as we look at the influence that the proxy advisors wield— 

we heard members of the subcommittee talk about some of the academic research, which is all in our written testimony. But the Center data for the 2013 proxy season gives a good illustration, talking 

about ISS recommendations against say on pay for S&P 500 companies. If you received an ‘‘against’’ recommendation, you got an 

average of 64 percent support for your say-on-pay vote, compared 

to about 93 percent if you got a ‘‘for’’ recommendation. 

And despite this influence, proxy advisory firms have no economic interest in the companies for which they are giving the recommendations. As one company told us, ‘‘It feels like we are giving 

power over the board to a consultant without a horse in the race.’’ 

As we also talk about in our written testimony, proxy advisory 

firms also influence company pay policies, and when we researched 

this among our subscribers we found that about 54 percent said 

that they had changed a pay practice, policy, or plan primarily to 

meet a proxy advisory firm’s standard. 

Let me talk for just a second about conflicts of interest and inaccuracies or errors. The practice that ISS practices of providing consulting services to corporate issuers on one side while providing impartial—or so-called impartial—recommendations to issuers and investors on the other is a conflict that we find very troubling because it creates the perception that there is an advantage to taking 

up the consulting. 

In addition, the consulting of ISS with investor clients that are 

shareholder proponents also creates the perception that ISS may 

favor those resolutions. And we believe that both practices should 

be prohibited. 

With respect to inaccuracies, there is an example in our testimony, and I would urge you to take a look at it, with respect to 

Eagle Bancorp, but about 53 percent of Center and HR Policy 

members said in the survey that a proxy advisory firm had made 

one or more mistakes in a final report during our research of this. 

Mr. Chairman, let me conclude by talking about the sentinel effect of oversight, and this harkens back to 2012. Again, it deals 

with ISS, the largest firm, which had adopted a new practice—a 

new methodology for determining peer groups. And the reason that 

peer groups are important in pay disclosures is the linkage between peers and pay-for-performance. If the peer group is wrong, 

the connection between pay and performance is likely not to be 

seen. 

And when the methodology was put out, about 23 of 45 S&P 500 

companies filed supplemental filings with the SEC saying that peer 

groups were a problem. This gained the attention of the SEC. And 

even in conversations with investors, they raised the issue and said 

they were going to raise it with ISS. 

All of this attention, in conjunction with popular press attention, 

led by early summer for ISS to say, ‘‘We are going to reexamine 

this.’’ They looked at it, and they changed it. We have even seen 

some of the salient effect since then on greater engagement with 

us. 

10 

And so with that, Mr. Chairman, thanks again for allowing us 

to testify, and I look forward to answering any questions you may 

have. 

[The prepared statement of Mr. Bartl can be found on page 38 

of the appendix.] 

Chairman GARRETT. And I thank you for your testimony. 

Next, Mr. Holch, the executive director of the Shareholders Communications Coalition. 

You are recognized for 5 minutes. 

STATEMENT OF NIELS HOLCH, EXECUTIVE DIRECTOR, 

SHAREHOLDER COMMUNICATIONS COALITION 

Mr. HOLCH. Thank you, Mr. Chairman. 

Chairman Garrett, Representative Sherman, and members of the 

subcommittee, my name is Niels Holch, and I am the executive director of the Shareholder Communications Coalition. The Coalition 

is comprised of the Business Roundtable, the National Investor Relations Institute, and the Society of Corporate Secretaries. The Coalition was established in 2005 after the Business Roundtable filed 

a petition for rulemaking with the SEC, urging the agency to conduct a comprehensive evaluation of the U.S. proxy system. 

Many of the current SEC shareholder communications and proxy 

voting rules were adopted more than 25 years ago in 1985 and remain unchanged. These SEC rules were promulgated during a period when most annual meetings were routine and very few matters were contested. They were also developed at a time when technology was not nearly as advanced as it is today. 

Just for perspective, these SEC rules were adopted when Ronald 

Reagan was starting his second term of office, the Dow Jones Industrial average was at 1,500 instead of 15,000, and Microsoft was 

still publishing software using its DOS operating system. 

After decades of inaction, the SEC began to tackle this problem 

in July of 2010, when it released for public comment a concept release describing concerns about the current proxy process and discussing possible regulatory solutions. Unfortunately, another 3 

years has now passed, and the SEC has not taken any action on 

its concept release. 

Let me now provide you with a brief summary of how the current 

proxy system is structured and why the Coalition believes reforms 

are essential; 70 to 80 percent of all public company shares in the 

United States are held in street name, meaning in the name of a 

broker or a bank rather than its customers, who are referred to as 

‘‘beneficial owners.’’ 

Under SEC rules, brokers and banks are responsible for distributing shareholder meeting materials provided by companies to 

their beneficial owners and processing their proxy voting instructions. Changes in corporate governance practices have accelerated 

the need for public companies to communicate more frequently and 

on a more time-sensitive basis with their shareholders. 

However, this is very difficult to accomplish under a system that 

is controlled by the brokers and the banks. Additionally, SEC rules 

classify investors as either ‘‘objecting beneficial owners,’’ called 

OBOs, or ‘‘nonobjecting beneficial owners,’’ called NOBOs. The public companies represented by the Coalition have one overriding goal 

11 

in this area: We want to know who our shareholders are, and we 

would like to be able to communicate with them directly. 

For these reasons, the Coalition supports the elimination of the 

NOBO–OBO classification rule. This would give public companies 

access to contact information for their beneficial owners and permit 

direct communications with them. Once public companies have access to shareholder information, they could assume responsibility 

for distributing proxy materials directly, making the process more 

efficient and promoting open communications. 

The proxy voting system also needs to be addressed. Reports in 

the news media of voting miscounts and delays in determining election results have raised questions about the integrity of the voting 

process. Proxy voting should be fully transparent and verifiable, 

starting with a list of eligible voters for a shareholder meeting and 

ending with the final tabulation of the votes cast at that shareholder meeting. 

Public companies are also concerned about the role and activities 

of private firms providing proxy advisory services to institutional 

investors. Proxy advisory firms should be subject to more robust 

oversight by the SEC. 

For example, the current exemption from the proxy rules that 

these firms enjoy should be conditioned on their meeting certain 

minimum requirements governing their activities. The SEC should 

also require registration of all proxy advisory firms under the Investment Advisors Act. Additionally, the SEC and the Department 

of Labor should review their existing rules and interpretations to 

make sure that institutional investors are complying with their fiduciary duties by exercising sufficient oversight over their use of 

proxy advisory services. 

As noted earlier, it has been more than 25 years since the SEC’s 

shareholder communications and proxy voting rules have been updated. The Coalition urges this subcommittee to request that the 

SEC turn its attention to addressing the issues raised in its 2010 

concept release. 

Thank you. 

[The prepared statement of Mr. Holch can be found on page 150 

of the appendix.] 

Chairman GARRETT. Thank you. 

Next, Mr. McCauley, from the Florida State Board of Administration. 

Welcome. You are recognized for 5 minutes. 

STATEMENT OF MICHAEL P. McCAULEY, SENIOR OFFICER, INVESTMENT PROGRAMS AND GOVERNANCE, FLORIDA STATE 

BOARD OF ADMINISTRATION (SBA) 

Mr. MCCAULEY. Thank you. 

Chairman Garrett, Representative Sherman, and members of the 

subcommittee, good morning. I am Michael McCauley, senior officer 

with the Florida State Board of Administration. I am pleased to appear before you today on behalf of the State Board of Administration. 

My testimony includes a brief overview of the State Board of Administration and its investment approach followed by a discussion 

of our proxy voting process and procedures and our use of proxy adVerDate Nov 24 2008 17:50 Nov 21, 2013 Jkt 081762 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 K:\DOCS\HBA156.160 TERRI
12 

visors to assist the SBA in fulfilling its proxy voting obligations. I 

will also discuss some proposed reforms that will make proxy advisors more transparent to the market and more accountable to their 

clients. 

The Florida State Board of Administration, or SBA, manages 

more than 30 separate investment mandates and trust funds, some 

established as direct requirements of Florida law and others developed as client-initiated trust arrangements. In total, the Florida 

SBA manages approximately $170 billion in assets, and under Florida law, the SBA manages the funds under its care according to fiduciary standards similar to those of other public and private pension and retirement plans. 

The SBA must act in the best interest of the fund beneficiaries. 

This standard encompasses all activities of the SBA, including the 

voting of all proxies held in funds under SBA management. 

In Fiscal Year 2012, the SBA executed votes on thousands of 

public companies—approaching 10,000; it was approximately 9,500 

individual meetings. The SBA makes all proxy voting decisions 

independently, and to ensure that the SBA meets its fiduciary obligations, it established the Corporate Governance and Proxy Voting 

Oversight Group, or the Proxy Committee, as one element in an 

overall enterprise risk management program. 

SBA voting policies are based both on market experience and balanced academic and industry studies, which aid in the application 

of specific policy criteria, quantitative thresholds, and other qualitative metrics. During 2012, the SBA issued guidelines for more 

than 350 typical voting issues and voted at least 80 percent of 

these issues on a case-by-case basis following a company-specific 

assessment. 

To supplement its own proxy voting research, the SBA purchases 

research and voting advice from several outside firms—principally 

the leading proxy advisory and corporate governance firms. When 

making voting decisions, the SBA considers the research and recommendations provided by advisors along with other relevant facts 

and research, as well as the SBA’s own proxy voting guidelines. 

But the SBA makes voting decisions independently and in what 

it considers to be the best interests of the beneficiaries of the funds 

it manages. Proxy advisor and governance research firm recommendations inform but they do not determine how the State 

Board of Administration votes, and they do not have a disproportionate effect on SBA voting decisions. 

In Fiscal Year 2012, again, the votes that the SBA executed correlated with the recommendations of one single proxy advisor firm 

67 percent of the time. Other historical reviews of SBA voting correlations have shown both lower and higher correlations with individual external proxy advisor recommendations, and that has been 

dependent on both the time period that was under study as well 

as the specific voting categories that were in question. 

While the SBA acknowledges the valuable role that proxy advisors play in providing pensions funds with informative, accurate research on matters that are put before shareowners for a vote, we 

believe proxy advisory firms should provide clients with substantive rationales for vote recommendations, minimize conflicts of 

interest, and have appropriate oversight. Toward that end, the SBA 

13 

believes that proxy advisors should register as investment advisors 

under the Investment Advisors Act of 1940. 

Registration would establish important duties and standards of 

care that proxy advisors must uphold when advising institutional 

investors. And additionally, the mandatory disclosures would expose conflicts of interest and how they are managed and establish 

liability for firms that withhold information about such conflicts. 

Mandatory disclosure should also include material information 

regarding the process and methodology by which the firms make 

their recommendations, aimed at allowing all stakeholders to fully 

understand how an individual proxy advisor develops those voting 

recommendations. This would make advisor recommendations more 

valuable to institutional investor clients and more transparent to 

other market participants, including corporations. In this way, registration would complement the aims of existing securities regulation, which seeks to establish full disclosure of all material information. 

Thank you, Mr. Chairman, for inviting me to participate in the 

hearing, and I look forward to the opportunity to answer any questions. 

[The prepared statement of Mr. McCauley can be found on page 

162 of the appendix.] 

Chairman GARRETT. And I thank you. 

Next, Mr. Morgan, from the National Investors Relations Institute (NIRI). 

STATEMENT OF JEFFREY D. MORGAN, PRESIDENT AND CHIEF 

EXECUTIVE OFFICER, NATIONAL INVESTOR RELATIONS INSTITUTE (NIRI) 

Mr. MORGAN. Thank you, Chairman Garrett, Representative 

Sherman, and members of the subcommittee for holding this hearing and for inviting the National Investor Relations Institute, or 

NIRI, to participate. 

My name is Jeff Morgan, and I am president and CEO of NIRI. 

Founded in 1969, NIRI is the largest professional investor relations 

association in the world, with more than 3,300 members representing over 1,600 publicly traded companies and $9 trillion in 

stock market capitalization. 

My written testimony focuses on the two topics of this hearing: 

proxy advisors; and improving communications and engagement between public companies and shareholders. I will focus my verbal 

comments on the communications aspect. 

An open channel of two-way communications is needed for any 

business between its owners and its investors. Businesses have an 

obligation to keep their owners informed on business operations, financial results, and other material information. Owners have an 

obligation to ensure management is operating within expected 

guidelines and to offer their input on key decisions. 

In all cases, I think most would agree that two-way communications is much less effective when each party doesn’t know who the 

other party is. That is the situation with public companies in the 

United States today and one of the many challenges we have with 

our capital markets and proxy system as they have evolved over 

the last several decades. 

14 

Shareholders know they own stock or equity in a company, but 

the company has limited ability to know who the shareowners of 

the company are at any point. Ultimately, better transparency in 

shareholder ownership would improve the two-way dialogue of companies and shareholders, creating healthier U.S. capital markets. 

While companies operate under a host of regulations, there are 

few regulations to allow for shareholder information to be provided 

to the company to ensure there is a healthy flow of information and 

dialogue from company to shareholders. 

One of the few mechanisms is the choice of shareholders to be 

registered or to hold shares in street name. Registered shareholders are those who directly register with the issuer or publicly 

traded company, thus enabling the company to know the identity 

of the shareholder, as well as providing for the free flow of information between the company and the shareholder. 

Street name shareholders are those who use a broker or bank to 

hold the shares on their behalf. While the street name shareholder 

is the beneficial shareholder, there is no direct registration with 

the company, and consequently, the company doesn’t necessarily 

know the shareholder’s identity. 

Prior to the 1970s, estimates are that approximately 75 to 80 

percent of shares were registered and about 20 to 25 percent were 

held in street name. Today, the opposite is true, with about 80 percent of shares in street name and 20 percent registered with the 

company. 

As our capital markets have evolved, companies have lost the direct linkage with their shareholders. The only report that provides 

some insight for a company into its larger shareholders is SEC filing Form 13F. While not specifically designed to help companies 

know who their largest shareholders are, Congress established a 

reporting regime in the late 1970s to provide public reporting by 

certain larger investment managers of their equity position. 

Every institutional manager who exercises investment discretion having an aggregate market value of at least $100 million on the 

last trading day of the month must file a Form 13F. Managers 

must file these reports with the SEC within 45 days after the last 

day of each quarter. 

The practical effect of this rule is that an investment manager 

may buy shares on January 2nd and not have to report that holding publicly until May 15th, more than 19 weeks after the transaction. This is hardly a productive way for issuers to know their 

shareholders. 

Recently, the NYSE, the Society of Corporate Secretaries, and 

NIRI submitted a petition to the SEC to reduce the reporting delay 

from 45 days down to 2 days. As part of Dodd-Frank, Congress 

mandated the SEC consider similar rules for short selling, requiring disclosure every 30 days. So we believe an evaluation of the entire equity ownership disclosure process as part of the evaluation 

of proxy mechanics and proxy advisors makes sense. 

With the increasing involvement of shareholders in corporate 

governance matters, it is clear that improvements to our system for 

linking shareholders and companies are needed. Public companies 

would welcome it, and this would dramatically increase the ability 

of companies to engage with shareholders. 

15 

Action in this area, combined with an examination of our 20- 

plus-year-old proxy system, including a focus on the proxy advisory 

service area, would go a long way to enhancing our proxy and 

shareholder communications process in the United States. 

In conclusion, thank you for the opportunity to testify, and I look 

forward to your questions. 

[The prepared statement of Mr. Morgan can be found on page 

169 of the appendix.] 

Chairman GARRETT. And I thank you for your testimony. 

Next up, from the Society of Corporate Secretaries & Governance 

Professionals, Ms. Stuckey is recognized for 5 minutes. 

STATEMENT OF DARLA C. STUCKEY, SENIOR VICE PRESIDENT, 

POLICY & ADVOCACY, SOCIETY OF CORPORATE SECRETARIES & GOVERNANCE PROFESSIONALS 

Ms. STUCKEY. Thank you, Chairman Garrett, Representative 

Sherman, and members of the subcommittee. 

I am Darla Stuckey, senior vice president at the Society of Corporate Secretaries & Governance Professionals. We have 3,100 

members representing about 1,200 public companies and about 

over half of those are small-and mid-caps. 

Reading proxy statements is time-consuming. Few investment 

managers will allocate capital to voting decisions that they believe 

will not generate a return on investment. In short, proxy voting, 

other than in a ‘‘bet the farm’’ type scenario, is simply not worth 

the cost. 

So outsourcing to proxy advisory firms is pragmatic, but many 

investors use their reports like CliffsNotes: They read the summary 

report but not the proxy. Some don’t even read the report; they just 

take the vote recommendation automatically. 

But proxy statements are subject to full 1934 Act liability and 

are filed with the SEC. Proxy advisory firm reports are not, but 

should be. 

My testimony will cover the proxy advisory firm influence and 

problems we have with their policies, conflicts, and errors. 

Due to the sheer volume of companies, proxy firm reports are 

based on one-size-fits-all policies. This is a problem simply because 

companies are not the same. 

Voting decisions and routine elections are even more important 

now than they have been with the advent of say-on-pay and majority vote for directors. Companies of all sizes now must navigate 

proxy advisory firm policies and guidelines. 

As you have heard, they control at least 20 percent and maybe 

upwards of 40 percent of the vote. This is much larger than the 

Schedule 13D threshold and even larger than the 10 percent affiliate status threshold, both of which require public reporting. 

In 2009 and 2010, IBM stated that the voting block that ISS controlled had more influence than its largest shareholder. This is the 

case even though the proxy advisory firms have no economic stake 

in the company and have not made meaningful disclosure about 

their power, conflicts of interests, or controls. 

Proxy firm voting policies are also not transparent. We don’t 

know how they are developed. Although ISS provides both issuers 

16 

and investors with an opportunity to take their survey, the questions are often skewed and biased towards a narrow agenda. 

We don’t know if the issuer’s voice counts, and the number of institutions who take the survey is very small. ISS reported 201 responses in 2010, representing only 15 percent of its institutional 

clients—even fewer since. So consider that 15 percent of ISS’ clients create policies that influence as much as 20 percent of the vote 

of every public company. 

They also influence corporate behavior. Just the threat of an 

‘‘against’’ vote causes boards to change their practices to satisfy the 

one-size-fits-all guidelines. ‘‘What will ISS say?’’ is regularly asked 

in the board rooms. 

Proxy advisory firms are also subject to conflicts, which you have 

heard, and which are discussed in my written testimony. 

I will explain one. Here is the story: One company member received a call from a sales representative from Equilar, a company 

working with Glass Lewis, 2 days after Glass Lewis recommended 

against their say-on-pay proposal. The rep wanted to sell the company a service that would shed light on the recommendation. 

The society member asked about the basis for the CEO compensation number that had been used because its CEO had 

changed in 2012 and it looked like Glass Lewis had used a composite of the former CEO’s compensation and the new CEO comp. 

But even still, the number was 45 percent higher than what was 

in the summary comp table. 

The member asked for an explanation, but the sales representative was unwilling to discuss it unless the company subscribed to 

their service, which was about $30,000. Indeed. 

And lack of access to reports is at the heart of the larger problem 

of mistakes. Until recently, a company could get its Glass Lewis report from its proxy solicitor or a law firm, but no longer. 

Instead, Glass Lewis will sell issuers a copy of the report for 

$5,000 or they can buy the $30,000 service I mentioned. So if an 

issuer wants to see the facts given to its investors, their only choice 

is to pay for the report. 

At the very least, proxy recommendation reports should be provided to all issuers in advance of publication, free of charge, to enable the issuer to check the factual accuracy of the report, because 

votes that are not based on facts are not informed votes and we 

don’t believe an institution can satisfy its fiduciary duties by relying on something that is not accurate or that it doesn’t know is accurate. 

Other problems: Aside from conflicts, the reports can contain 

mistakes. One example relates to ISS’ peer group selection methodology. A small-cap member wrote to me yesterday—somebody with 

no access to the report in advance—telling us that last week, ISS 

also recommended against its say-on-pay proposal. 

Here is what he described: The ISS peer group bears almost no 

relationship to our industry. We are an e-mail data security company. We sell B-to-B. They have designated as peers consumer-oriented online media companies, personal dating sites, online games, 

et cetera, that have nothing to do with our industry. We don’t compete with these companies for talent and we have been consistently 

17 

profitable for the measurement period, whereas most of the companies to which they compare us have not been. 

In sum, both investment advisors and proxy advisory firms must 

have an obligation to ensure that vote recommendations are based 

on accurate facts and are in the best economic interests of the 

shareholders. 

Thank you. 

[The prepared statement of Ms. Stuckey can be found on page 

222 of the appendix.] 

Chairman GARRETT. Thank you. 

And having the final word on the topic—well, maybe not—Mr. 

Turner, you are recognized for 5 minutes. 

STATEMENT OF LYNN E. TURNER, MANAGING DIRECTOR, 

LITINOMICS 

Mr. TURNER. Thank you, Chairman Garrett. It is indeed an 

honor to be invited back again to testify before the committee, and 

I would like to thank you and Representative Sherman. 

I would like to make a few key points today, and my points will 

be based upon my past experience: I have been a member of the 

corporate boards of public companies which were subject to the recommendations of the proxy voting firms; I have been on the board 

of two institutional investors who did the proxy voting; I have been 

a financial executive, vice president, in a large international semiconductor company; I was a former regulator at the SEC; and I 

also was a senior executive and head of research at Glass Lewis 

during its initial formative years, from 2003 to 2007. 

First, let me note that proxy voting is an important right to the 

owners of public companies. Proxy voting provides investors with 

a very useful market-based mechanism with which to establish the 

accountability of both the board of directors and management, 

which is what makes our capital market system work. 

Second, many investors and their asset managers take this responsibility very seriously. If you look at the Web sites of the largest public pension funds and the 15 largest money managers, such 

as Fidelity, Vanguard, and Blackrock, you will find they all have 

their own custom designed proxy voting guidelines, as well as staff 

dedicated to proxy voting. These custom guidelines are similar at 

times to those of the two proxy advisory firms on issues, but this 

is because investors do have some common views on what is good 

governance in the corporate community. 

Third, asset managers may buy research from the proxy voting 

services to gather useful information and assist with their analysis 

of the issues. However, it is not uncommon that they will vote differently than ISS or Glass Lewis and their recommendations and 

often vote with management. And certainly, one would think that 

buying of such research to add to one’s available information about 

the issue should not be criticized in the context of trying to be fully 

informed about an issue. 

Fourth, in today’s global markets an investor asset manager is 

going to invest in dozens of capital markets around the globe. At 

COPERA, we invest in 7,000 to 8,000 companies. A proxy advisory 

firm like Glass Lewis or ISS may issue recommendations on 20,000 

to 40,000 proxies a year around the globe. 

18 

Clearly, the mutual funds and the pension funds don’t have the 

staff to go through all of those. It would be cost-prohibitive. It 

would take well over 100 staff, I believe, based on my experience, 

to read each of those in depth, do the analysis, and vote the 8,000 

proxies in a global marketplace. 

If you had to add those staff to your pension fund or your mutual 

fund, it would drive up the cost to investors significantly and reduce their returns. I doubt people want to do that. 

Fifth, there is a significant amount of transparency today when 

it comes to proxy voting. ISS, to their credit, goes through a phenomenal public comment process, not dissimilar from what the 

Federal regulators here in this government do. They post their 

guidelines to their Web site; they talk about their methodologies on 

their Web site. Most proxy and pension funds also post their proxy 

voting guidelines, as I have previously mentioned. 

Sixth, pension and mutual funds do not view their proxy voting 

guidelines as rigid documents. Quite often, when the circumstances 

are appropriate, we will turn around and vote differently than their 

guidelines. It is not a one-size-fit-all, as some would argue. 

Seventh, if there is a bias in proxy voting it is, in fact, towards 

management. In 2002 at PERA, we voted with management about 

86 percent of the time. Even on shareholder proposals, we still 

voted with management about 60 percent of the time. 

And I think in the statement by the Council of Institutional Investors, and the statement you heard from Florida, they also indicated a bias towards management. In fact, on the say-on-pay proposals so far to date this year, there have been approximately 2,473 

votes, and only 31 have failed; less than 2 percent have failed. 

When I was going to college, I would have signed up quickly for 

any class where you had a 98.5 percent passing rate. This is not 

way out of the mark. 

Eighth and finally, I will just say that there are about 100 proxy 

voting contests each year that get a lot of attention. It is typically 

because of a lack of performance, if you looked at the recent example on Hewlett Packard, for example—very contested, a lot of visibility in the media. In that case, Hewlett Packard had been underperforming in the market, had lost over $30 billion in market 

share, had turned around and had negative performance in excess 

of 20 percent over the previous 5 years, and was in the lower quartile in their industry during that time period. That is what causes 

the disputes on the proxy voting. 

Thank you, and I would be happy to answer any questions. 

[The prepared statement of Mr. Turner can be found on page 345 

of the appendix.] 

Chairman GARRETT. Great. Thank you. 

So again, I appreciate the panel’s testimony, and we will now go 

to questioning. I will try to run down the list in 5 minutes. 

Chairman Pitt, in your written testimony you didn’t exactly say, 

you inferred, that the Egan-Jones no-action letter is one of the 

main reasons that the largest proxy firms—we just basically have 

two of them, a duopoly at this point. So for all practical purposes, 

is it correct to say that the decision by the SEC—and that was 

done by the staff, correct, not by the Commission—has eliminated 

19 

any fiduciary responsibility for the actual mutual funds themselves 

and the investment advisors? 

Mr. PITT. I think it is correct to say that those letters have enabled institutional investors to sidestep their fiduciary obligations 

instead of actually fulfilling them themselves. 

Chairman GARRETT. Right. And if they had a fiduciary responsibility—just to lay this out clearly—that responsibility would be to 

whom? 

Mr. PITT. That is correct. They have— 

Chairman GARRETT. To whom would it be if they had a fiduciary 

responsibility? Who were you talking about? To the investor? 

Mr. PITT. They do have clear fiduciary responsibilities. 

Chairman GARRETT. If those letters basically obviated, eliminated, diminished the fiduciary responsibility by the mutual fund 

or the investment advisor to the little investor out there, let’s see, 

did it shift that responsibility someplace else? Does the proxy advisor now have that fiduciary responsibility to the investor? 

Mr. PITT. No. The fiduciary duties still remain with institutional 

investors. They cannot divest themselves of their fiduciary obligations. 

What the no-action letters do is provide a vehicle for them to 

outsource the exercise of— 

Chairman GARRETT. Right. So basically, it says it satisfied the 

responsibility by going to a proxy advisor. 

Mr. PITT. That is correct. 

Chairman GARRETT. Right. 

Does the proxy advisor—if I am the little investor, does the proxy 

advisor now have a fiduciary duty to me, because I can’t go back 

to the mutual fund? 

Mr. PITT. I believe that they do not have the same fiduciary duties that the institutional investors have because the institutional 

investors owe their fiduciary duties to the shareholders in those institutions. Proxy advisory firms— 

Chairman GARRETT. Right. 

Mr. PITT. —do have clear obligations of truthfulness and the like, 

and those are akin to fiduciary duties, but they are not the same 

fiduciary duties. 

Chairman GARRETT. Someone on the panel—I don’t think it was 

you—made reference to the idea of just making them responsible 

as an investment advisor. Would that solve the problem? 

Mr. BARTL. Yes. I don’t think that was me, but— 

Chairman GARRETT. No, it wasn’t. But would that solve the problem? Because you were the one who said— 

Mr. BARTL. In terms of registration as an investment advisor, because of the services that proxy advisors provide, it in and of itself 

is not going to put them in the shoes of investors because they are 

in sort of a quasi-role between analyzing company plans and giving 

advice to investors. It is almost a different animal altogether. 

Chairman GARRETT. Right. You did point out, though, that they 

basically just don’t have, as you put it colloquially, a ‘‘horse in the 

race,’’ so they don’t have that interest in it. 

But you also raised also another potential conflict, which is interesting, with regard to the advice that they actually sell to the firms 

as well, which puts them into an additional conflict situation. 

20 

Mr. BARTL. Yes. And the interesting part here is that the companies still perceive that there is an advantage, and when proxy advisors provide advice on one side of the house and the other side of 

the house is giving the rating, regardless of whatever disclaimers 

are made—in fact, ISS even says, ‘‘Don’t tell us by contract—don’t 

tell us that you talked to our consulting side if you come to the research side to tell us about your proxy’’—it is a bit of a kangaroo 

court. The— 

Chairman GARRETT. Let me just break, because I only have 30 

seconds here—I appreciate your kangaroo court opinion. 

Ms. Stuckey and Mr. McCauley—Ms. Stuckey, you sort of say 

that the one-size-fits-all does not work for these, and Mr. McCauley 

sort of indicates that is true in the sense that 67 percent of the 

firms don’t rely upon them exclusively for the advisors. And yet 

some firms rely on them exclusively. Is that right, Ms. Stuckey? 

Ms. STUCKEY. That is right. There is even a recommendationonly service that some investors can buy where they don’t even get 

the reports at all because they don’t have time to read them. It is 

really the lowest common denominator; it is like a compliance obligation on behalf of many smaller investors—not Mr. McCauley. 

Chairman GARRETT. Right. Just checking the box. I appreciate 

that. 

And my time has expired. 

I now recognize the gentleman from California. 

Mr. SHERMAN. Mr. Turner, I want to thank you for pointing out 

that the same proxy advisory firm could tell two different clients 

a recommendation to vote in different ways just because they are 

given different criteria and they correspond to that criteria, just as 

a beer advisor might advise me to buy one beer because it tastes 

great and advise him to buy a different beer because it is less filling. 

In California, we do everything by referendum. In effect, every 

voter gets a proxy statement from the California Secretary of State; 

it is paid for by the corporation, that is, the State government legislature puts various referendum on the ballot. And the opponents 

get as much space in that book as the proponents of those referendum. 

Few Democrats and, I assure you, many fewer Republicans 

would advocate that only the management of the California legislature be allowed space in that proxy statement. If anybody wants 

to draw an analogy to the corporate world, they are welcome to do 

so. 

Ms. Stuckey, if someone was listening perhaps not as closely as 

they should have to your testimony, they would have thought you 

were advocating that these recommendations all be filed with the 

SEC where they would be public. That would mean that everybody 

who wanted to see these reports could see them for free and that 

would, of course, abolish the proxy advising industry. 

I have a series of questions I want to ask everybody— 

Ms. STUCKEY. May I respond to that? 

Mr. SHERMAN. No, because I am sure you didn’t mean to do that. 

I just want to caution those who might not have listened carefully 

enough to your testimony. I want to go on. 

We are here to talk about shareholder rights. 

21 

Mr. Turner, you are representing yourself, but everybody else 

here is representing an organization, so I would ask them to respond as to official positions of their organization. 

Please raise your hand if the folks you represent have taken a 

position in favor of requiring cumulative voting for all corporations 

publicly listed. 

Only Mr. McCauley’s hand goes up. 

How many of your organizations have taken a position in favor 

of information being in the proxy statement about $1 million-plus 

political expenditures? 

No hands go up. 

We have a circumstance where you may have a management and 

a board that is just doing a terrible job, and yet it takes 3 years 

to vote on the board because only one-third of the board is up every 

election. How many of your organizations have taken a position in 

favor of allowing the entire board to be replaced within 365 days? 

Mr. McCauley raises his hand; no one else raises their hand. 

As I alluded to before—and I know that we would have to—if we 

wanted a statute on this, we would have to package it a different 

way to pass the courts, but there are those who think that if 5 percent of the shareholders want to put forward a proposal or an argument to vote for a particularly different slate of directors, that they 

should be able to use corporate money to do that just as the corporate management does. How many of you favor a proposal along 

those lines? 

Mr. McCauley raises his hand—thank you very much—for the 

record. 

Mr. Pitt, I heard you say that the proxy advisor had an obligation to advise the investors based upon their economic interest. Do 

I have that right? 

Mr. PITT. To further the economic interests of investors, yes. 

Mr. SHERMAN. Okay. So let’s say I want to invest not for rate of 

return but I want to invest in companies that will build a strong 

manufacturing base in the United States even if that gives me a 

lower rate of return. Should it be illegal for me to find a proxy advisor who will help me achieve that objective through my votes in 

the companies I already own? 

Mr. PITT. Absolutely not. 

Mr. SHERMAN. So we should have investment advisors who give 

advice based on something other than the economic interest of the 

investor. 

Mr. PITT. I think your point is that the advice should be tailored 

to the interests of investors, and I quite agree with that. 

Mr. SHERMAN. Okay. Should a pension plan management be subject to lawsuits alleging that they have breached their fiduciary 

duty simply because they chose to invest or vote based on what 

they thought was good environmental policy or good antiterrorism 

policy? 

Mr. PITT. If they are subject, for example, to ERISA, yes. 

Mr. SHERMAN. Did your organization support legislation that 

would allow pension plans to divest from those companies investing 

in Iran? 

Mr. PITT. I am sorry, to invest on what? 

22 

Mr. SHERMAN. To divest from those companies investing in Iran. 

Did you support or oppose that legislation? 

Mr. PITT. No. 

Mr. SHERMAN. You did not support or oppose? 

Mr. PITT. I’m sorry. I know I am— 

Mr. SHERMAN. Okay. There was legislation before this committee—finally passed years too late—over the under-the-table opposition of the organization you are representing that would simply 

allow Mr. McCauley to divest from companies giving money to the 

ayatollahs in Iran without facing lawsuits, and I wondered if that 

was still your position. 

Mr. PITT. I don’t believe that the Chamber opposed that legislation. 

Mr. SHERMAN. There was a reason it didn’t pass until long after 

it should have. 

I yield back. 

Chairman GARRETT. The gentleman yields back. 

The gentleman from Virginia? 

Mr. HURT. Thank you, Mr. Chairman. 

I do have a couple of questions for the panel. I did want to allow 

Ms. Stuckey the opportunity to respond to what the gentleman 

from California alleged in his question. 

I just wanted to give you a moment to respond, if you would like? 

Ms. STUCKEY. I would just like to say that we are not advocating 

these proxy advisory firms be put out of business. We believe they 

have every right to exist. 

But yes, I did say that we would like their reports filed and they 

could be filed after the fact. We don’t want them to give away their 

competitive information, but we do think that having the reports 

filed will make them think harder about what they are doing and 

making sure they get it right. 

Mr. HURT. Thank you. 

I guess, let’s start with Mr. Pitt on this question: Obviously, the 

SEC has the responsibility to encourage capital formation, investor 

protection, and fair and efficient markets, and to that extent, Congress has that responsibility, I think, to encourage policies that do 

encourage capital formation and encourage that formation to take 

place in our public markets that have served us well, I think, since 

the founding of our country. And so to that extent, it seems that 

this is an important issue that results or has consequences for 

those three objectives of the SEC. 

You said in your statement, I believe, that you don’t think these 

issues necessarily require more government regulation, but I would 

like to know what specifically we or the SEC should be doing to 

solve the conflict of interest problem and, perhaps, the misalignment of fiduciary duties? If you could just address that, and then 

I would like to hear from Mr. Bartl and Mr. Holch. 

Mr. PITT. Yes. I think first and foremost what the Chamber has 

done is published best practices and core principles. It would be 

very constructive if this subcommittee encouraged all of the participants to engage in a good faith, meaningful dialogue on those principles, and to come up with a consensus view on the ways in which 

this industry should be performing and should practice, and I think 

if that occurs, there may never be a need for formal regulation. If 

23 

that doesn’t work, obviously this subcommittee should consider additional steps. But until that dialogue begins, there is clearly no 

predicate made for a regulatory solution. 

Mr. HURT. Okay. 

Mr. Bartl? 

Mr. BARTL. Yes. Thank you, Vice Chairman Hurt. 

I think one aspect—and I talked about it in my testimony—but 

is persistent and ongoing oversight in conjunction with maybe the 

development of best practices because those that are overseen by 

the SEC and by this body tend to pay more attention, and we saw 

that in my peer group example. 

The other thing is that regulation may have the effect of entrenching the existing participants in the system, and there was 

actually another player in this space until 2 years ago, Proxy Governance, and one of the things they commented on was the ability 

of the larger players in this space to basically wipe them out economically. So if we are looking for greater competition, as Mr. Scott 

talked about, that is one thing to keep in mind here. 

Mr. HURT. Thank you. 

Mr. HOLCH. Congressman, the Coalition is for regulation here— 

not something of Dodd-Frank complexity, but what I would call 

light touch regulation. We do believe that we will need some ability 

to regulate in order to solve these problems. We are not opposed 

to best practices as an approach, but we do believe that these— 

Mr. HURT. What are the specifics of— 

Mr. HOLCH. Sure. ISS, for example, is already registered as an 

investment advisor, but the Investment Advisors Act—the current 

framework really doesn’t apply to their role. Their role is very 

unique. They are not selecting investments for their clients; they 

are providing advice on proxy voting. 

And so we think the SEC should create a unique regulatory 

framework that reflects their role using their authority under the 

Investment Advisors Act: first, we would be for registration; second, we also think that unique framework should address some of 

these transparency problems that we have identified, address the 

factual inaccuracy issue that we have also talked about; and third, 

we do think both the SEC and the Department of Labor should 

evaluate their fiduciary duty rules and interpretations regarding 

investment advisors just to clarify and to make sure that these investment advisors are providing the proper oversight. 

Mr. HURT. Thank you. 

Chairman GARRETT. I thank the gentleman. 

The gentlelady is recognized for 5 minutes. 

Ms. MOORE. Thank you so much, Mr. Chairman. Before I start 

my questioning, I would like to ask unanimous consent to enter 

into the record the testimony of Sean Egan, chief executive officer 

of the Egan-Jones Rating Company. It has been mentioned here. 

Chairman GARRETT. Yes. Without objection, it is so ordered. And 

since you are doing that, I will use this time also to enter into the 

record a— 

Ms. MOORE. You are using my time— 

Chairman GARRETT. No, I won’t be using your—oh, your time 

is— 

Ms. MOORE. Right. 

24 

Chairman GARRETT. [Off mike.] 

Ms. MOORE. Right, right. So get that clock back—my 25 seconds. 

Chairman GARRETT. I wasn’t going to use your time. I agree to 

just entering testimony into the record. 

Ms. MOORE. Okay. You are running the hearing. You can do it, 

but— 

Chairman GARRETT. We are going to reset you to 5 minutes; and 

we are going to put the June 4th letter from the Mutual Fund Directors Forum into the record, as well. Without objection, it is so 

ordered. And the gentlelady’s time is set back to the original 5 minutes. I will even throw another 10 seconds on— 

Ms. MOORE. Thank you so much, Mr. Chairman. 

I just want to start out by thanking the panel for coming. This 

is a very, very interesting conversation. 

I think that I heard some really broad agreement here, some 

things that we need to think about whether or not the SEC ought 

to regulate this industry more adequately. I think we did hear 

some agreement—perhaps not from Ms. Stuckey; I am going to ask 

her some more questions—about the value of having these rating 

companies do the intense research that they have done. 

And so with that, let me start out by asking Mr. Pitt—Honorable 

Mr. Pitt, I found it very interesting in your testimony that you said 

these rating companies didn’t have a horse in the race, or skin in 

the game, so to speak, and so I was wondering whether or not you 

thought that—and since another objection that many people have 

is that there are often conflicts of interest, I was wondering if you 

didn’t think that by them not having a horse in the race, their information might be more objective and it might be as a service? 

Mr. PITT. I don’t believe that affects their objectivity. Glass 

Lewis, for example, has a parent that is an activist investor and 

Glass Lewis takes positions on their positions. ISS takes positions 

with respect to companies that also purchase corporate governance 

services from them, so— 

Ms. MOORE. Okay. Okay, thank you. That is good information. 

Do you think regulation would change that? 

Mr. PITT. I think best practices and adopting fiduciary standards 

would help. 

Ms. MOORE. Okay. Thank you for that. 

Ms. Stuckey, I was very interested in your—everybody else 

seemed to think that these companies did bring something to the 

table, and maybe you clarified it a little bit when you were given 

time to say that you don’t think they should be out of business, but 

you say that they produce a product and the—sort of the cost-benefit is not realized. I guess I wanted to hear just a little bit—a few 

seconds—about whether or not you thought they brought any useful information to the table. 

Often, companies internally cannot afford to do all this research 

that they need in order to make good investment advice, so I wanted you to clarify that for us. 

Ms. STUCKEY. We are companies. We like our shareholders. Our 

shareholders tell us they need this type of information from the 

marketplace. We don’t have a problem with that. 

Ms. MOORE. Okay, good. I— 

25 

Ms. STUCKEY. We don’t have a problem with that. What we have 

a problem with, though, is when we write a 100-page proxy according to the SEC rules and then the services take the proxy and they 

use junior people, perhaps—they use people who they—they are 

trying to make money so they use maybe people who don’t really 

understand these things—they are complicated, they come up with 

a summary report which then gets sent to the investors—not all investors, but a lot of them—and they don’t have time to read our 

proxy— 

Ms. MOORE. I understand. 

Mr. Turner, I am going to let you have the last word on this. You 

mentioned something that hasn’t come up previously in questioning 

about the board of directors’ lack of access to the ballot, and how 

it disadvantages certain types of proxy voters like labor unions. So 

I want you to talk about that, and also I want you to respond to 

the whole skin in the game and cost-benefit points that have been 

made. 

Mr. TURNER. I do think having access to the proxy is extremely 

important for investors. At our pension fund, which represents half 

a million investors, the fund has voted to support proxy access, so 

we are a strong proponent of that, as many of the funds are. 

As far as the cost-benefit here, first of all, it is not just junior 

staff who are preparing these things. That is a misnomer; that is 

a myth that needs to be busted wide apart. Those things are reviewed by senior people on up. 

It is just the same as an audit firm does when they do an audit. 

Junior staff do a lot of the work. Congressman Sherman knows this 

very well. But before that product goes out, senior people up the 

level do review it, so they are credible. 

And in fact, I have found in using their reports that most of the 

time, they are credible. If you are going to do 40,000 reports a year, 

are there going to be some misses? Yes. But for the most part, they 

are well done. 

And the benefit of that to the investing public is immense because you usually get—in our case, we even get not only one research report, we get a couple of pieces of information that supplements what we do as our people do read the proxies at the PERA 

board, and it does provide a number of different viewpoints, which 

is the best way to become a well-informed voter. So I think the system does work. 

I actually do agree, I would do some form of registration and 

take care of the conflicts, but for the most part, the system is much 

better than what some would say. 

Ms. MOORE. Thank you. 

Chairman GARRETT. I thank the gentlelady, and I thank the gentleman. 

The gentlelady, Mrs. Wagner, is recognized for 5 minutes. 

Mrs. WAGNER. Thank you, Mr. Chairman. 

And I would like to thank the witnesses for being here today. 

Mr. Morgan, I want to focus specifically on retail investors and 

how the proxy process is working or not working for them specifically. In your opinion, do you feel that the proxy process is easy 

for the average retail investor to understand? 

26 

Mr. MORGAN. Thank you for the question, because they are the 

missing piece in all of this. 

Mrs. WAGNER. I agree. 

Mr. MORGAN. Retail investors do not have access to the—because 

they don’t pay the fees to proxy advisors. Most of them are not registered with the company; they are in street name. 

So they come through a proxy process and there is not a lot of 

communication. They get their proxy. As Darla said, it is 100 

pages. They look at it, they are confused. Many of them don’t vote. 

Retail voter accounts that vote is about 14 percent. It is terrible. 

We just don’t have the retail shareholders engaged, and I—part of 

the changes to a proxy system would hopefully address that to 

allow them to become reengaged in the process— 

Mrs. WAGNER. Let me get to that. So you do believe that it is the 

complexity, I guess, of the proxy process that has led to a lower 

level of retail investors’ participation? 

Mr. MORGAN. I would say it is the complexity as well as we are 

legally required to provide these proxies, and in order to meet all 

the requirements; they are very dense. So it makes it very difficult 

for a retail shareholder who isn’t engaged in this to understand 

them. 

Mrs. WAGNER. Then what steps can we take to simplify the proxy 

statements so that the information could actually be meaningful to 

retail investors? 

Mr. MORGAN. I think part of it is when we tell investors something, let’s tell them once, and put all this information out there 

so it is easily understandable. I think looking at the system, as we 

have talked about, registered shareholders versus those in street 

name, we need to look at the process and try to bring it back to 

how it was to where there is more dialogue and engagement so 

they feel more informed when they are making their decisions and 

feel more empowered. 

Mrs. WAGNER. So then the complexity, would you say, of the 

proxy system has caused almost an overreliance on proxy advisory 

firms at the expense of retail investors? 

Mr. MORGAN. I wouldn’t necessarily say that. I would say that 

retail shareholders are on their own, and by being on their own 

they don’t have the tools that institutional investors do. 

Mrs. WAGNER. All right. Let me focus with Chairman Pitt, 

please, if I could. 

There are thousands of public companies that had nothing to do 

with the financial crisis of 2008, yet a number of these companies 

have been targeted by activist shareholders in recent years. DoddFrank was passed as a supposed antidote to the financial crisis, 

but how has Dodd-Frank encouraged some of these activist shareholders to promote their agendas at nonfinancial companies? 

Mr. PITT. It has in many ways. For example, it undertook to Federalize a large portion of corporate governance, which heretofore 

has been the province of State law. That in itself has been a very 

troubling development as part of the legislation. 

It then takes issues that are perhaps important but that don’t affect the material outcome of a company’s behavior, such as conflict 

minerals— 

Mrs. WAGNER. Right. 

27 

Mr. PITT. —doing business in certain countries, and it has now 

encouraged people to use corporate disclosure documents for purposes other than informing investors. 

Mrs. WAGNER. I think you are quite right. 

I want to also ask about what was in your testimony regarding 

Section 951 of Dodd-Frank, the so-called say-on-pay provision. Why 

do you feel that ISS and Glass Lewis decided that these say-on-pay 

votes should be held yearly as opposed to every 2 years or even 

every 3 years? 

Mr. PITT. The problem with this is Congress, in its wisdom—and 

it was wisdom—gave companies and shareholders a choice of 1, 2, 

or 3 years. But ISS and Glass Lewis adopted a one-size-fits-all position and have effectively been able to mandate that all corporations 

do this on a yearly basis. This is expensive and it doesn’t produce 

any value for shareholders, and there are studies that say it actually has acted to the detriment of shareholders. 

Mrs. WAGNER. All right. Thank you. 

Mr. Chairman, I think I will yield back my time since it is waning. Thank you very much. 

Chairman GARRETT. If she yields it to me, I will just ask this 

question to Mr. Morgan: Glass Lewis is owned by the Ontario 

Teachers Fund, correct? 

Mr. MORGAN. Correct. 

Chairman GARRETT. So where are the retail investors who are 

looking to being protected in that situation? Who is Glass Lewis actually responsible to, their owner or the retail investors? 

Mr. MORGAN. They are, as an institutional investor those institutional investors represent those individuals, so there is an intermediary there. So we were talking two different things. One is the 

direct— 

Chairman GARRETT. Understood. But is there a potential for conflict when you have a proxy advisor being owned by a— 

Mr. MORGAN. Oh, absolutely. It is a huge potential conflict. 

Chairman GARRETT. Thank you. 

With that, I yield to Mr. Scott for 5 minutes. 

Mr. SCOTT. Thank you, Mr. Chairman. 

Like to continue a line of questioning from my colleague who 

mentioned about the say on pay. It is good for us sometimes to be 

able to look around corners to see what is coming, and there is a 

gathering storm that is coming at us, and it is this huge gap in 

pay. We dance around it. 

But I want to ask you, because—and I mentioned the question 

about just having 2 firms control 97 percent of the market, and let 

me just give you a glaring point on why this compensation issue 

and perhaps this almost monopoly with two companies might have 

something. 

Last year, proxy advisor firm Glass Lewis urged votes against 

management on their pay and compensation 17 percent of the time. 

ISS urged votes against their management on their compensation 

pay 14 percent of the time. But yet, 98 percent of U.S. companies 

got the majority of support on their compensation plans last year. 

And I am wondering, at what point are we going to begin to realize that this cannot continue? 

28 

We are a mass consumption economy, which means our success 

hinges on many, many people being able to buy many, many 

things. And so, the credibility is at stake. It is these people who 

invest in the market—in their pensions, in their retirements. 

I am wondering, and I would like to ask—perhaps Mr. McCauley 

or Mr. Pitt or Mr. Turner may have touched upon some of this— 

either of you, what must we do about this? Why is it that, one, we 

have just 2 companies controlling 97 percent of this, and does this 

have anything to do with why we are not getting the kind of response to taking a very jaundiced eye look at the seriousness of 

this huge gap on compensation between the top and the middle and 

the bottom and the impending damage that it could do to our economy? 

Mr. PITT. The reason I think we only have two companies is because of the government policies that have existed, and I would 

urge you to consider an analogy. We saw the exact same thing with 

credit rating agencies before the 2007 and 2008 meltdown, where 

competition based on government policies was reduced and restricted. And as one of the panelists indicated, new entrants into 

this field have found it impossible and have been unable to compete. So one problem is that there is no facilitation of competition 

here. 

The issue you raise about compensation, in my view, is a very 

serious one. I start from the premise that people should be rewarded for performance, not for having a pulse. And so when compensation comes up, it is absolutely crucial for companies to do the 

due diligence that is required to set what standards they want and 

then to develop metrics to measure whether senior executives have 

actually met those metrics. 

Although the SEC has tried to promote better disclosure, the real 

problem is that many companies today simply cannot get their 

arms around the process of setting compensation. 

The one place where I have a concern, however, is that I don’t 

think it is the appropriate role for government to try and figure out 

what is good compensation or appropriate compensation. But I do 

agree with you: The bigger the disparity, the more potential problems we will have, and it is up to companies to do the discipline 

and then make appropriate disclosures of what they have done. 

Mr. SCOTT. I thank you. 

Chairman GARRETT. Mr. Hultgren is recognized for 5 minutes. 

Mr. HULTGREN. Thank you, Mr. Chairman. 

Thank you all for being here. 

Chairman Pitt, wonder if I could address some questions to you. 

Can you describe how the SEC’s regulation of proxy voting—specifically the 2003 rules governing institutional investors’ fiduciary obligation to clients when voting client proxies and also the 2004 noaction letters—contributed to the rising influence of proxy advisory 

firms over the last decade? And also, how is this scenario similar 

to the SEC’s rule mandating the use of credit rating agencies? 

Mr. PITT. Yes. In 2003—and I was Chairman at the time—the 

Commission adopted rules which said that registered investment 

advisors should disclose how they—what policies they apply in voting proxies, and then at some point after a vote was taken disclose 

how they voted so people could see whether the policies aligned. 

29 

And the theory was, these shares belong to the investors not to the 

managers, and therefore there at least ought to be policies with respect to that. 

What happened thereafter was that the SEC staff issued two noaction letters, which effectively permitted registered investment advisors to obviate their own responsibilities with respect to voting 

and instead rely on proxy advisory firms as a general proposition 

to eliminate potential conflicts that any investment manager might 

have with a particular company situation. 

The no-action letters were unique in that instead of responding 

the way most no-action letters do, as you would write in, for example, to the SEC and say, ‘‘Here is what I am planning to do. Can 

I do this?’’ And the SEC would say, ‘‘Yes, you can do it, based on 

the facts we know. We won’t bring any action.’’ These no-action letters effectively amended the SEC’s rules without any action by the 

Commissioners. 

What this did was create an impetus in favor of the two largest 

firms and the existing firms and made it easier for them to sell 

their services based on the fact that there was no requirement for 

investment managers to look to their own conflicts of interest if 

their policy was to solicit and get advice from these third party persons. 

With respect to credit rating agencies, the SEC had provisions— 

and I was astounded to learn this when I got back there—that established nationally recognized credit rating agencies and then 

made it impossible for other entrants to compete. And the result 

was that you had an oligopoly and a lack of real standards. 

Mr. HULTGREN. You kind of touched on this, but Chairman Pitt, 

by allowing mutual funds and investment advisors to outsource 

that fiduciary duty to act in their client’s best interest when voting 

their proxies to proxy advisory firms has the SEC effectively decoupled the voting decision from the fiduciary duty? 

Mr. PITT. I am sorry. Has the SEC— 

Mr. HULTGREN. Effectively decoupled the voting decision from 

the fiduciary duty? 

Mr. PITT. I think that is a fair statement. 

Mr. HULTGREN. Taking this a little further, should mutual funds 

and investment advisors be allowed to outsource that fiduciary 

duty to proxy advisory firms in your opinion or in the thoughts of 

the Chamber? And what reforms—I know you have talked about 

some of these in your statement, but what reforms need to be made 

to ensure that proxy advisory firms are making recommendations 

that enhance shareholder value? 

Mr. PITT. Let me say first that the Chamber is studying this 

issue. I can answer for myself, and my view is that outsourcing of 

fiduciary responsibilities breaches the whole concept of fiduciary 

duty, so I believe that the answer has to be yes, you can go out 

and obtain this kind of guidance, but in the end you must exercise 

your own fiduciary responsibilities and you cannot rely on others 

to do that for you. 

Mr. HULTGREN. Okay. 

Mr. Chairman, I see my time is just about out. I will yield back. 

I don’t know if you have a— 

Chairman GARRETT. No. I will— 

30 

Mr. HULTGREN. Okay. I yield back. Thank you. 

Chairman GARRETT. Thanks. 

I now recognize Mr. Mulvaney. 

Mr. MULVANEY. Thank you, Mr. Chairman. 

It strikes me that many of the complaints we are hearing are 

sort of typical when you are operating in a marketplace where 

there are only two providers, or 2 providers provide 97 percent of 

the services, so I want to drill down a little bit on the questions 

that my colleagues, Mr. Scott and Mr. Hultgren, just asked and 

start with you, Mr. Pitt, because clearly one reaction would be to 

regulate this industry because of the apparent concentration of 

market power, but obviously competition would be another possible 

solution. 

You said a couple of times in the last couple of answers that 

there are government policies that are preventing new entrants, 

but I haven’t heard the specifics yet on what those policies are. 

What is it specifically that the government is doing that is preventing you and me from going into this business and starting a 

new competitor? 

Mr. PITT. I think that some of the policies that exist are an indifference, if you will, to the fact that the existing advisory firms engage in a one-size-fits-all approach, that there is no sense of concern about the failure of the two major proxy advisory firms to consider the best financial interests of shareholders, and— 

Mr. MULVANEY. Okay, but let me catch up. Indifference is not a 

policy. There is a difference between the government getting involved to promote competition, okay—we could do things to try and 

encourage competition, but there are also things we do to discourage competition. 

Is there anything that this government is doing now that is discouraging me and Mr. Hultgren from getting into this industry? 

Because indifference is not a policy. 

Mr. PITT. Yes. I think with respect to the subject of the no-action 

letters, for example, the grant by the SEC staff of the ability of the 

existing proxy advisory firms to permit registered investment advisors to focus on their general policies instead of whether there is 

a specific conflict has diminished the ability to create competition 

in this field. 

Mr. MULVANEY. So if you and I, or me and Mr. Hultgren, want 

to start another—we can’t get that same treatment. Is that what 

you are saying? 

Mr. PITT. Yes. 

Mr. MULVANEY. Someone else help me out here. What am I missing? Is there something else? Why aren’t there more competitors in 

this market? 

Don’t everybody jump up at one time. 

Mr. HOLCH. I will take a crack at— 

Mr. MULVANEY. Mr. Holch, yes, sir? 

Mr. HOLCH. I think one of the problems is for institutional investors you need to have a certain amount of scale to function in this 

market. You have to cover 13,000 annual meetings. The proxy 

statements, as Darla Stuckey said earlier, average 100 pages. You 

need to be of a certain size to really service the marketplace. 

31 

There have been other firms that have tried to get into the retail 

space and have really failed miserably because the retail shareholders won’t pay for it, either. So I think there is a sort of a price 

and a cost dynamic that makes it really difficult to compete. 

Mr. TURNER. Having started Glass Lewis, I would totally agree 

with that. There have been others in the marketplace that didn’t 

get to the scale and failed financially, so you have to be able to almost immediately—we had to go out and get venture capital backing to give us the ability to ramp up quickly because we had to be 

able to cover 5,000 or 10,000 companies right out of the gate, so 

you have to have the ability to raise some money, to ramp the 

scale, put in the technologies, and then get institutional investors 

to be willing to sign on. 

And they are reluctant to sign on to someone who has never done 

it before, so—and it is not a big marketplace. If you look at the revenues at Glass Lewis and ISS combined, they are probably in the 

$250 million to $350 million range. This is not a big marketplace. 

The ability to get a return if you do invest in a company like this 

is not that great, so I just don’t think you are going to see—financially the market just isn’t going to support any other entrants. 

Mr. MULVANEY. Mr. Bartl? 

Mr. BARTL. Yes. It is interesting. If you look at the current market participants and the scale and the competition between them, 

you have one player in ISS that is substantially bigger. When 

Glass Lewis makes an attempt to move, you see a countermove as 

well by ISS, and if you look at the announcement by Glass Lewis 

last spring of greater engagement with its investors, ISS announced its feedback review board. Whether the two are connected, 

I don’t know, but you saw that. 

Mr. MULVANEY. Okay. 

Mr. BARTL. You saw peer groups with Glass Lewis and using a 

more market-based participation. In addition to the blow-up I discussed on peer groups, ISS adopted a similar procedure as part of 

its procedure when it revised its process for 2013. So, getting into 

the market and staying in deals with market participation, and 

this has been discussed in other settings before by other organizations that have explored the competition in the market. 

Mr. MULVANEY. Okay. That is helpful, because that is not where 

I thought Mr. Pitt was going. I thought there was something we 

were doing to prevent that type of competition, which you have just 

described can be experienced in many industries where economies 

of scale simply prevent new entrants, so that is sort of a natural 

barrier to entry. 

And there are different ways to deal with that, Mr. Pitt, than 

dealing with something we are doing to affirmatively prevent competition, so that is extraordinarily helpful. 

I yield back. Thank you, Mr. Chairman. 

Chairman GARRETT. Thank you. 

The gentleman from California? 

Mr. ROYCE. Thank you, Mr. Chairman. 

I would like to ask Mr. Pitt a couple of questions. Last year, 

Glass Lewis offered vote recommendations for the Canadian Pacific 

Railway shareholders meeting and the Ontario Teachers Pension 

Board, the parent company of Glass Lewis—opposed the board of 

32 

directors of the Canadian Pacific Railway. Not surprisingly, Glass 

Lewis issued a recommendation that shareholders oppose the incumbent board of directors and vote for an alternative slate. 

According to a letter sent by the Chamber of Commerce to the 

SEC, the case represents tangible conflicts of interest in the operation of proxy advisory firms. 

What I wanted to find out—the chairman has discussed this 

issue, and you have alluded to it as well—is how common are these 

types of instances, and would disclosing a conflict of interest such 

as this be sufficient or, in your judgment, Harvey, is it necessary 

to take more prescriptive measures in order to address this, other 

than just disclosure? 

Mr. PITT. I think that at present, the disclosure that exists is 

very vague and generic, i.e., ‘‘We may have positions or our parent 

may have positions,’’ and then Glass— 

Mr. ROYCE. That is not disclosure, right— 

Mr. PITT. It is not. When I was chairman, that is what the research analysts did, and we prohibited that. 

Mr. ROYCE. Right. 

Mr. PITT. I think one thing that has to occur is you have to disclose real conflicts on real time. The second is there has to be an 

accepted standard of behavior for these firms. 

We think that can be achieved consentually. If that fails, then 

there may be a need for government action, but right now ISS and 

Glass Lewis have no interest in developing appropriate standards 

on conflicts. 

Mr. ROYCE. The post-Andersen debacle led to a situation where 

what was once presumed effective Chinese firewalls—clearly postdebacle that was addressed, and we get into the issue here of ISS, 

and certainly the SEC and the GAO both pointed out conflicts of 

interest arise when an advisory firm runs a consulting business 

alongside its proxy advisory services. 

And there are times when they may be asked to advise on shareholder proposals sponsored by someone who obviously is also paying them on consulting work. Now, what is surprising is when you 

go through the record how many cases you can find. 

In 2011, AFSCME sponsored a shareholder proposal at Target 

Corporation, and that same year AFSCME paid ISS as a client. In 

2010, the Nathan Cummings Foundation sponsored a shareholder 

proposal at Masco while paying ISS for, again, advice. In 2010, the 

Connecticut Retirement Plans and Trust Funds sponsored a shareholder proposal at Abercrombie and Fitch, and that same year the 

Connecticut State Treasurer confirmed in a letter to the SEC that 

the State was a client of ISS, and that she would support initiatives to clarify potential conflicts of interest on the part of proxy 

advisory firms. 

So sure, these should be disclosed, but I want to take it a step 

further. And maybe I could ask Mr. Morgan on this, because Mr. 

Morgan in his written testimony called this an inherent conflict of 

interest. 

The question is, what would the solution be, in your opinion? 

Mr. MORGAN. Certainly, if you can’t regulate it starts with transparency, and those conflicts should be stated and shown on any 

recommendation that they make that they are also providing conVerDate Nov 24 2008 17:50 Nov 21, 2013 Jkt 081762 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 K:\DOCS\HBA156.160 TERRI
33 

sulting services for these activists or whoever is proposing that position. So I think that would be the starting point so that when the 

recommendation is read you can see that there is—they have also 

supplied consulting services. 

Mr. ROYCE. Harvey, would that be sufficient, in your opinion? 

Mr. PITT. It could be. I think one of the things that would solve 

this problem would be to eliminate the effect of these no-action letters that permit firms not to detail specific conflicts of interest before they recommend positions with respect to those companies. 

Mr. ROYCE. Thank you. Thank you, Mr. Chairman. I yield back. 

Chairman GARRETT. The gentleman from California now yields 

back. 

That concludes the questioning from all the Members who are 

here. We have just agreed with the ranking member that we will— 

if the panelists can sit through 10 more minutes, we will do an additional 5 minutes on each side. 

The gentleman from California will have his 5 minutes. I will 

share with whoever is still here on our side, or I will use the 5 minutes. 

But with that, I will yield to the gentleman from California. 

Mr. SHERMAN. I will, of course, generously share my 5 minutes 

with all the other Democrats who are here. 

Mr. Pitt, do I as a—let’s say there are two panels running for 

board of directors, one of which is committed to divesting from 

Iran, protecting the environment, and promoting American jobs. 

The other, in my opinion, is going to earn one cent more per share 

for all the shareholders. Do I as a shareholder have a fiduciary 

duty to my fellow shareholders to vote for that second panel? 

Mr. PITT. I don’t think fiduciary duty determines which way you 

vote. I think fiduciary duty dictates that your standard should be 

what is in the best interests of those to whom you owe the duty, 

and— 

Mr. SHERMAN. As I said, these are my own shares. 

Mr. PITT. If you conclude that in the long run, a certain vote will 

promote the best interests of those shareholders, then— 

Mr. SHERMAN. Okay. I own these shares. They are mine. Do I 

have a fiduciary duty to vote in the best interests of all those other 

people who have invested in IBM stock? 

Mr. PITT. No. 

Mr. SHERMAN. Or can I—okay. 

Mr. PITT. No. You vote your shares for any reason. 

Mr. SHERMAN. Ms. Stuckey, you suggested an after-action filing 

of the report. Let’s say the Smith Family Trust has decided—its 

trustees—a big foundation, maybe a big family trust—that they 

want to divest from Iran but they have decided they don’t want to 

divest from Sudan. If the report given to them by their investment—their proxy advisors is filed with the SEC then everyone in 

the country will know that the Smith family is good on Iran but 

they are not tough on Khartoum. Is that fair? 

Ms. STUCKEY. I think so, under that scenario. 

Mr. SHERMAN. So you think that if the Smith family—just a family trust, a couple of brothers put their money in—have decided 

that they are going to pick their— 

34 

Ms. STUCKEY. You don’t know for sure that they followed the recommendation. 

Mr. SHERMAN. Are you saying that if Jack Smith and John Smith 

have an investment partnership and they choose to get advice on 

how to vote their proxies— 

Ms. STUCKEY. And assuming they were— 

Mr. SHERMAN. —that the entire world has to know what their 

proxy voting criteria are? 

Ms. STUCKEY. If they are an institutional investor with a fiduciary duty— 

Mr. SHERMAN. I didn’t say an institutional investor; I said Jack 

and John Smith. 

Ms. STUCKEY. Jack and John Smith probably didn’t buy the 

proxy advisory firm services. They are probably a retail— 

Mr. SHERMAN. In my example, I said they were relatively 

wealthy brothers with a big trust. They can buy what they want. 

Ms. STUCKEY. Then they have no obligation to— 

Mr. SHERMAN. They have no obligation— 

Ms. STUCKEY. —follow the recommendations or not. They can 

just— 

Mr. SHERMAN. So now, let’s say it is an ERISA pension plan. Do 

you think they have an obligation to disclose their voting criteria? 

Ms. STUCKEY. Yes. 

Mr. SHERMAN. Okay. 

Let’s see. I didn’t know we would get a second bite at this apple. 

So, Mr. Pitt, is it the Chamber’s belief that we should have this 

race to the bottom by the different States in trying to deprive 

shareholders of any meaningful control and that corporations 

should be—publicly traded corporations should be free to incorporate in whichever State has the least cumulative voting, the 

longest terms for board members, et cetera? Should we have minimum national standards or should we invite States to try to get 

this business from other States by offering the most pro-management corporate law? 

Mr. PITT. With all due respect, there is a mixed metaphor. The 

Chamber supports high standards; they do not support a race to 

the bottom. With respect to the issue— 

Mr. SHERMAN. How would we get those high standards? Or can 

you be in a position to say, ‘‘We as a Chamber support high standards but we support a system in which States will naturally race 

to the bottom and the Federal Government won’t stop them?’’ 

Mr. PITT. The support should be—and I think is—for the system 

as originally adopted by Congress, which is that the States decide 

the substantive rights of shareholders, and there are a lot of very 

strong reasons why that was a very wise policy. 

Mr. SHERMAN. And it has given us the weakest possible shareholder protection. 

I see my time has expired. I yield back. 

Chairman GARRETT. Thank you. 

And for the final 5 minutes, so in the testimony that we have received today on one of the issues dealing with say on pay—and I 

will throw this out to Ms. Stuckey and Mr. Bartl—Congress was 

pretty explicit as to how say on pay was going to play out, or 

should play out, but the way the proxy advisors basically played it 

35 

out was in contradistinction to where Congress is. That is to say, 

it would be, what, every year. 

Do you see by them doing that as a conflict or a contradiction 

from Congress as it is laid out, or as a potential conflict from their 

interest to the investors in this situation? 

I will start with Ms. Stuckey. 

Ms. STUCKEY. I think say-on-pay votes being every year certainly 

increases the need for their services, so they are perpetuating 

themselves in business. I will add to that, when companies get recommendations that they don’t like, they talk to their investors. So 

they go out and talk to their investors now more than they ever 

did before. 

There are companies that tell us, ‘‘We talked to every single one 

of our top 50 investors, and they all want 3-year say on pay.’’ 

Chairman GARRETT. Okay. 

Mr. BARTL. I would simply echo that, Mr. Chairman. And even 

for those who aren’t saying, for 3 years now, they have been saying, 

‘‘We are going to look at this over the time being,’’ simply because 

the workload involved in an annual say-on-pay analysis versus the 

benefit received is something that is starting to weigh on the investor, as well. So there is definitely a vested interest in keeping it 

at one year. 

Chairman GARRETT. Okay. 

Just two other points. First of all, we got into a little bit—actually, the testimony was Mr. Holch, with regard—and some others, 

as well—to the point of what can be done, and you laid out some 

of these points as to help facilitate more direct communications between the entities—the companies and the investors. And I think 

there is unanimity on the panel that this is something that would 

be good to work on, and the Congress should take an additional 

look at, that there is a problem in this area, and this is an area 

where Congress has a role to try to help facilitate. Mr. Holch? 

Mr. HOLCH. The SEC has the authority to repeal their NOBO– 

OBO rules, which I described in my testimony. The SEC also has 

the authority to switch the responsibility of communicating with 

shareholders from the brokers and the banks over to the public 

companies. 

But certainly Congress has a role, and I think it would be great 

if members of this subcommittee could help us encourage the SEC 

to move this along. The public company community has waited a 

long time to try to address these issues and we are supported by 

a number of institutional investors. There really is a consensus for 

change, and so we just need to get this up the priority list over at 

the SEC. 

Chairman GARRETT. There are a couple of different areas that we 

heard from on this overall panel, and hopefully, this is one area 

where we may find some degree of agreement, and some degree of 

bipartisanship on as we look at it further. 

The area where we may have a little bit more dissention is the 

role and the—how we deal with proxy advisors. My takeaway—and 

someone can correct me if it is wrong—is that there is—whether 

we are talking about the retail—yes, when we are talking about 

the retail investor, there is still a lack of clarity as to what the obligation is of the proxy advisor to my mom, the small retail investor, 

36 

of the proxy advisor. There is no obligation, basically. Yes, not clarity—I should say there is no obligation. 

Conversely, there—thank you. Mr. Morgan is agreeing with me 

that there is no obligation of the proxy advisor to the retail investor. 

The other takeaway that I am getting from this as well is that 

there might be—or there are various conflicts that the proxy advisor currently has, whether it is the one that Ms. Stuckey talked 

about just now, the one that Mr. Bartl talked about earlier with 

regard to the selling of services on the side, if you will, and also 

the one that others have pointed out, the potential conflict of basically who owns these proxy advisors, and who their largest clients 

also are may influence their decisions as to their advice on these 

things. 

Mr. Turner is shaking his head ‘‘no,’’ but as of right now, I can’t 

see why there is not a potential for a conflict of interest when they 

do not owe me or the small retail investor and there is not disclosure or transparency as to what those potential conflicts are. Those 

potential conflicts potentially can exist, and I think that is something that we can take a look at. 

And I will close on this, on the happy note that I think Chairman 

Pitt raised, that maybe some of this can be done just on a consensus basis with trying to bring the interested parties together, 

because now Congress is taking a focus on it. I will end on that 

happy note, although I think that when two entities have 97 percent of the market share, I have a feeling that they probably don’t 

have a whole lot of interest in trying to reach any compromise on 

this, but we will remain optimistic. 

I thank all of you for your testimony. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous 

materials to the Chair for inclusion in the record. 

With that, we are now adjourned. 

[Whereupon, at 12:00 p.m., the hearing was adjourned.] 

(37) 

A P P E N D I X 

June 5, 2013 

38 


81762.001

A CASE FOR GREATER OVERSIGHT OF THE PROXY 

ADVISORY FIRM INDUSTRY 

Hearing on Examining the Market Power and Impact of Proxy 

Advisory Firms 

Subcommittee on Capital Markets and 

Government Sponsored Enterprises 

House Committee on Financial SeNices 

June 5,2013 

Written Testimony of 

Timothy J. Bartl 

President 

Center On Executive Compensation 

Center On Executive Compensation 

1100 THIRTEENTH STREET I SUITE 850 

WASHINGTON DC 20005 

202.408.8181 I FAX 202.7890064 I WWW.EXECCOMP.ORG 
39 


81762.002

Chairman Garrett, Vice Chairman Hurt, Ranking Member Maloney and Members of the 

House Financial Services Committee: 

My name is Tim Bartl, and on behalf of the Center On Executive Compensation, I am 

pleased to provide our views on the role, influence and impact of proxy advisory firms. 

These issues have been a top concern of the Center's for several years, and led to the 

Center's publication in January 2011 of a white paper, "A Call for Change in the Proxy 

Advisory Industry Status Quo: The Case for Greater Accountability and Oversight." We 

used the paper to begin a dialog on these issues both with the proxy advisory firms and 

more importantly, several leading institutional investors. My comments today reinforce 

many of the findings and recommendations in the paper and are punctuated by recent 

examples of why proxy advisory firm accountability and oversight deserve this 

Subcommittee's attention as well as the SEC's. I would ask that the complete paper be 

inserted into the record as part of this hearing. 

The Center On Executive Compensation is a research and advocacy organization that 

seeks to provide a principles-based approach to executive compensation policy. The 

Center is a division ofHR Policy Association, which represents the chief human resource 

officers of over 340 large companies, and the Center's more than 100 subscribing 

companies are HR Policy members that represent a broad cross-section of industries. 

Because chief human resource officers support the compensation committee chair with 

respect to executive compensation and related governance matters, and many are 

involved in engaging with institutional investors, we believe that our Subscribers' views 

can be particularly helpful in understanding proxy advisory firm influence and the 

positive impact regulatory oversight had in 2012. 

I. The Role of Proxy Advisory Firms 

Proxy advisory firms fill an important role for institutional investors. As the share 

of institutional investor ownership has grown from roughly 46 percent in 1987 to over 75 

percent today, J the volume of proxy votes which investors are responsible for casting has 

grown into the billions. In order to assist them in fulfilling their fiduciary duty to vote 

their proxies in the best interests of their clients, most institutional investors retain the 

services ofInstitutional Shareholder Services ("ISS"), the largest proxy advisory firm, or 

Glass Lewis & Co., the other major proxy advisory firm. Together, these firms cover 

about 97 percent of the U.S. market for proxy advisory firm services.2 

Both ISS and Glass Lewis provide proxy voting research and analysis and make 

voting recommendations to their clients. Both companies provide an electronic proxy 

voting platform in which investors can instruct advisors on how they want their votes cast 

and the proxy advisory firms will execute the votes on investors' behalf. Both allow 

investors to customize their standardized proxy voting guidelines. ISS will also 

determine votes for its clients, and, based on ISS comments and anecdotal experience 

from our Subscribers, many medium and smaller investors delegate their proxy voting 

I THE CONFERENCE BOARD, 2008 INSTITUTIONAL INVESTMENT REPORT: lRENDS IN INSTITUTIONAL 

INVESTOR ASSETS AND EQUITY OWNERSHIP OF U.S. CORPORATIONS (Sept. 2008). 

2 James K. Glassman and J.W.Verret, How to Fix Our Broken Advisory System, Mercatus Center (2013), 

http://mercatus.org/publicationlhow-fix-our-broken-proxy-advisory-system 
40 


81762.003

duties directly to ISS, following the ISS standard proxy voting guidelines. Glass Lewis 

does not determine votes on behalf of its clients, but is also less forthcoming about its 

voting policies and their application. 

As discussed in detail below, while most investors take their proxy voting 

responsibilities seriously, the delegation of proxy voting analysis to ISS and Glass Lewis 

inserts a significant opportunity for influence over the proxy voting system. Many 

institutional investors do not view proxy voting as enhancing returns for their clients. 

This leads to cost pressures on the proxy advisors and impacts the quality of their 

analyses. This led one commentator, Charles Nathan, then of Latham and Watkins, to 

observe: 

The effectiveness of this model rests on the assumption that voting decisions can 

be delegated to specialists and third-party proxy advisors so as to fulfill the 

institution's fiduciary duties without imposing undue costs on the institution. It 

is not clear, however, that the parallel voting universe that ha~ evolved over the 

past 25 years successfully discharges institutional investors' fiduciary duties of 

due care and loyalty.' 

The lack of sufficient resources on the part of the proxy advisors leads to a checkthe-box mentality, driven in part by the desire of investors to have a uniform, condensed 

version of corporate pay disclosures, even though pay programs are individualized, 

complex and lengthy. The speed with which proxy advisors must analyze 1 DO-page 

proxies, combined with the aforementioned lack of resources, leads to errors, 

inaccuracies or questionable characterizations. The system belies the reality that pay 

programs are nuanced and strive to link directly with corporate strategy. To understand 

and summarize them well requires time, resources and diligence. The irony is that issuers 

are responsible for ensuring the accuracy of proxy advisory firm reports, even though 

proxy advisory firms are supposed to be the experts providing information that investors 

rely on to execute a fiduciary duty. This calls into question the legitimacy of the model, 

or at least its effectiveness, given that only large companies have the opportunity to 

review a draft report, and then only from ISS. 

Policy Setting: Is It Truly a Reflection oj Investor Clients' Views? 

Of the two major proxy advisory firms, ISS has by far the clearest and most 

transparent policy development process. However, the process ISS follows to develop 

and refine the policies by which it analyzes thousands of company proxies involves a 

survey which is often relied on in making changes that typically does not have robust 

investor involvement. Last year's survey, conducted from July 24 to August 31, and 

incorporated feedback from only 97 institutional investors and 273 corporate issuers.4 

3 Charles M. Nathan, The Future of Institutional Share Voting: Three Paradigms, HARVARD LAW SCHOOL 

FORUM ON CORPORATE GOVERNANCE AND FINANCIAL REGULATION, July 23, 20 I 0, 

http://blogs.law.harvard.edu!corpgov!20 1 0/0 7!23!the-future-of-institu tional-share-voting-three-paradigms! 

(last visited June 3, 2013) 

'Institutional Shareholder Services, 2012-2013 Policy Survey Summary of Results (Sept. 2012), at 2, 

http://,,,·ww.issgovcrnance.com/files/pri vatellSS Po I icySu rvey Resu lts20 12. pd f 

2 
41 


81762.004

ISS notes that in addition to the survey, its Policy Board incorporates input from 

"roundtables with industry groups and ongoing feedback during proxy season" as well as 

informal discussions. 5 This was clearly the case in 2012, which is an encouraging sign. 

However, in discussions with institutional investors over the past year, certain ones have 

raised concerns about aspects ofISS's analyses which have not been changed. This 

demonstrates that there is still room for further consultation with all interested parties. A 

major example of a disconnect and its subsequent resolution-the selcction of peer groups 

for the purpose of comparing pay and performance in 2012- appears to have been one 

turning point in the process and is discussed later in these comments. 

Although analyses by proxy advisory firms has improved in recent years, the overall 

concerns remain with the policies through which proxy advisory firms exert significant 

influence over proxy voting and executive compensation and governance best practices. 

The SEC's Concept release on the proxy advisory system took a positive step to review 

concerns with proxy advisory firm practices, but with other rulemaking priorities likely to 

take priority, further legislative and regulatory oversight is in order. 

II. Proxy Advisory Firm Influence 

Both academic research and experience demonstrate that proxy advisory firms have 

significant influence over the proxy votes cast by institutional investors and over the 

compensation practices adopted by companies. This is a concern because unlike 

directors or institutional investors, proxy advisory firms have no economic interest in the 

company for which they are making recommendations. This removes the consequences 

of an inaccurate or incorrect recommendation from the recommendation itself. 

Influence of Proxy Advisory Firms Over Proxy Votes. Several research reports and 

academic studies have catalogued the influence of proxy advisory firm recommendations 

on shareholder votes. For example: 

• ISS clients typically control 20 to 30 percent of a midcap to large cap 

company's outstanding shares, while Glass Lewis clients typically control 5 to 

10 percent, according to Innisfree MA. 6 

• Opposition by a proxy advisor resulted in a "20% increase in negative votes 

cast" according to a 2012 study by David F. Larcker, Allan L. McCall and 

Gaizka Ormazabal.7 

5 Institutional Shareholder Services, 2012-2013 Policy Survey Summary of Results (Sept. 2012), at 2, 

http://www.issgovemance.com/files/private/ISSPolicySurveyResults2012.pdf. 

6 Yin Wilczek, Bounly Program 10 Cramp Corporate Boards: ABA Speakers Discuss Governance 

Provisions. DAILY RErORTFOR EXECUTIVES, Aug. 10,2010. 

7 David F. Larker, The Economic Consequences of Proxy Advisor Say-on-Pay VOling Policies, HARVARD 

LAW SCHOOL FORUM ON CORPORATE GOVERNANCE AND FINANCIAL REGULATION, November 12, 2012, 

http://blogs.law.harvard.edu/corpgov/20 12/11 !l2/the-economic-conseguences-of-proxy-advisor-say-onpay-voting-policiesl (last visited June 3, 2013). 

3 
42 


81762.005

• An academic study found that a negative vote recommendation by ISS on a 

management proposal resulted in a reduction in affirmative votes by 13.6 

percent to 20.6 percent. 8 

One of the most notable changes in proxy votes over the last thrcc years has been the 

introduction of annual nonbinding votes on executive compensation. The Larcker 

research mentioned above found that among 2,008 firms in the Russell 3000, "firms that 

reccived a negative recommendation by ISS (Glass Lewis) obtained an average 68.68% 

(76.18%) voting support in SOP proposals. In contrast, firms that did not receive a 

negative recommendation from ISS (GL) obtained an average of93.4% (93.7%) support 

in those proposals." 9 

The Larcker research is generally consistent with Center research. As of May 31, 

2013, S&P 500 companies holding say on pay votes which experienced a change in 

recommendation from "For" in 2012 to "Against" in 2013 expericnced a decrease in 

support of26.4 percent, while companies receiving a positive recommendation received 

93 percent approval on average. This is nearly identical to the results from the complete 

2012 proxy season. The data shows a strong link between the ISS recommendation and 

the resulting votes. 

Influence of ISS Voting Policies on Corporate Executive Compensation Programs. 

The voting results do not fully capture changes that companies make to their 

compensation policies in order to "score" better under proxy voting policies, particularly 

those ofISS. In a 2010 survey conducted by the Center and HR Policy Association, 54 

percent of respondents said they had changed or adopted a compensation plan, policy or 

practice in the past three years primarily to meet the standard of a proxy advisory firm. A 

2012 survey by the Conference Board, NASDAQ and the Stanford University Rock 

Center for Corporate Governance found that over 70 percent of directors and executive 

officers stated that their compensation programs were influenced by proxy advisory firm 

policies or guidelines. 1o 

The Larcker research also looked at the impact of these preemptive changes on the 

risk-adjusted return investors earned after such changes by analyzing companies that 

announced compensation changes prior to the say on pay vote in an 8-K filing. The study 

found that "the average risk-adjusted return on the 8-K filing date is a statistically 

significant -0.42%.11 Moreover, this effect is unique to 8-K changes in the time period 

before [the say on pay vote] and similar results are not observed for earlier time 

periods.,,12 Based on this research, excessive focus on the recommendations of proxy 

advisors not only appears detrimental to share price, it is likely moving companies away 

from sound pay for performance strategies, as discussed below. 

8 Jennifer E. Bethel & Stuart L. Gillan, The Impact of the Institutional and Regulatory Environment on 

Shareholder Voting, FINANCIAL MANAGEMENT 29, 30 (Winter 2002). 

9 Larker supra note 4. 

10 The Conference Board, The Influence of Proxy Advisory Firm Voting Recommendations on Say-an-Pay 

Votes and Executive Compensation Decisions (20 J 2), htlps:llwww.conferenceboard.orglretrievefiJe.cfm?filename~TCB-DN-V 4N5-12.pdf&type~subsite. 

II Larker supra note 4. 

12Id. 

4 
43 


81762.006

Example of the Negative Impacts of Proxy Advisory Firm Influence in Light of Say on 

Pay. Prior to say on pay taking effect, there was significant concern about the influence 

of proxy advisory firms in combination with the say on pay vote around the time say on 

pay was passed. For example, former TIAA-CREF General Counsel and current 

Chairman of Governance for Owners USA Inc., Peter Clapman, indicated "the inevitable 

consequence [of adopting say on pay] would be to transfer considerable discretionary 

power over individual company compensation practices to the proxy advisory firms. I 

question that such an approach will serve the long-tenn best interests of shareholders." 

Likewise, Columbia Law Professor Jeffrey Gordon indicated that "the burden of annual 

voting would lead investors, particularly institutional investors, to farm out evaluation of 

most pay plans to a handful of prox6 advisory firms who themselves will seek to 

economize on proxy review costs." 3 

A prime example of how the mandatory say on pay vote has transferred considerable 

power to proxy advisory firms, as Mr. Clapman indicated, is the three-part quantitative 

pay for performance test ISS uses to initially determine its say on pay vote. The Relative 

Degree of Alignment test, which is accorded the greatest weight under the quantitative 

test, measures whether CEO pay and total shareholder return for the subject company is 

aligned with CEO pay and total shareholder return for the peer companies selected by ISS 

over one and three years. The way pay and TSR are measured under the test is likely to 

identify some companies whose pay and performance are aligned as not being aligned 

and vice-versa because the time periods for assessing pay and performance are 

inconsistent, and the analysis is over weighted toward one-year pay and performance. 

• Mix of Actual and Hypothetical Pay. Under the Relative Degree of 

Alignment Test, pay is defined as total pay in the Summary Compensation 

Table of the proxy statement, which is a mix of actual and hypothetical pay. 

Specifically, total pay consists of compensation actually paid in the form of 

actual salary, annual incentive and/or bonus and long-term cash incentives, 

and the accounting estimates of equity compensation and other compensation. 

• Inconsistent Time Periods Used to Assess Pay and Performance. Under the 

test, performance is defined as total shareholder return over one- and threeyears. However, for most CEOs the m<tiority of compensation is paid in the 

form of equity incentives which are granted and valued within two and half 

months of the beginning of the fiscal year being reported, while ISS measures 

total shareholder return as of the end of the fiscal year. In making the grants, 

the compensation committee would not have known the TSR as of the end of 

the year. Under the assessment, pay and performance are not likely to be 

aligned because the time period for the bulk of pay (equity compensation) and 

the time period for performance are not consistent. A more logical approach 

would be to compare the TSR from the end of the fiscal year preceding the 

reporting year so that pay and performance would be more closely aligned. 

IJ Jeffrey Gordon, 'Sayan Pay ': Cautionary Noles on the UK Experience and Ihe Case for Shareholder 

Opt-In 325 (Columbia Law & Economics Working Paper No. 336; European Corporate Governance Ins!. 

Working Paper No. 117/2009, Aug. 2009). 

5 
44 


81762.007

• Assessment Double Counts One Year Pay and Performance. The ISS analysis 

compares one-year TSR against one-year total CEO pay (weighted 40 percent) 

and three-year TSR against CEO pay over three years (weighted 60 percent). 

Consistent with a view of most institutional investors, the Center supports a 

longer term view of pay versus performance. However, the Center believes 

that the analysis proposed by ISS effectively double counts the one-year pay 

for performance measurement because the most recent year of pay and 

performance is counted under both the one-year and three-year TSR/pay 

comparison. One-year TSR is typically not very helpful in assessing 

performance due to short-term fluctuations of Wall Street, yet the ISS 

approach pushes toward a shorter-term orientation rather than a view of longterm pay for performance. 

The ISS Relative Degree of Alignment test has led some companies to revise pay 

programs to try to get a better score, regardless of whether the approach is soundly 

aligned with company strategy. It has also led companies to experiment with alternative 

pay disclosures to tell their pay for performance stories directly to investors and to show 

more clearly that pay is aligned. The SEC's forthcoming requirement for the disclosure 

of pay actually received versus financial performance will likely force a discussion over 

similar time frames for assessing pay and performance among the proxy advisors. 

III. The Regulatory Framework Has Reinforced Proxy Advisory Firm Influence 

Proxy advisory firms have grown influential due in large part to two regulatory 

pronouncements, one by the U.S. Department of Labor, which announced the proxy 

voting duties of ERISA retirement plan sponsors in a 1988 opinion letter, and SEC rules, 

published in 2003. The DOL letter, commonly known as the "Avon Letter," stated that 

shareholder voting rights were considered valuable pension plan assets under ERISA, and 

therefore the fiduciary duties of loyalty and prudence applied to proxy voting. The Avon 

Letter stated: 

In general, the fiduciary act of managing plan assets which are shares of 

corporate stock would include the voting of proxies appurtenant to those 

shares of stock. For example, it is the Department's position that the 

decision as to how p/oxies should be voted ... are fiduciary acts of plan 

asset management. 

The Avon Letter further stated that pension fund fiduciaries, including those that 

delegate proxy voting responsibilities to their investment managers, had a responsibility 

to monitor and keep accurate records of their proxy voting. 15 

The SEC further reinforced the concept of fiduciary duties related to proxy voting in 

2003 by adopting a rule and amendments under the Investment Advisers Act of 1940 

pertaining to mutual funds and investment advisers desifned to encourage funds to vote 

their proxies in the best interests of their shareholders. I The new regulations required 

14 Letter from Allan Lebowitz, Deputy Assistant Sec'y of the Pension Welfare Benefits Admin. at the U.S. 

Dep't ofI_abor, to Helmuth Fandl, Chairman of the Ret. Bd., Avon Products, Inc. (Feb. 23,1988). 

15 Jd. 

16 Sec. Exch. Comm'n, Final Rule: Proxy Voting by Investment Advisers, Advisers Act Release No. 1A2106,17 C.F.R. § 275 (Jan. 31, 2003). 

6 
45 


81762.008

mutual funds to: I) disclose their policies and procedures related to proxy voting and 

2) file annually with the Commission a public report on how they voted on each proxy 

issue at portfolio companies. 17 

Similarly, investment advisers were required to: I) adopt written proxy voting 

policies and procedures describing how the adviser addressed material conflicts between 

its interests and those of its clients with respect to proxy voting and how the adviser 

would resolve those conflicts in the best intercsts of clients; 2) disclose to clients how 

they could obtain information from the adviser on how it had voted proxies; and 3) 

describe to clients all proxy voting policies and procedures and, upon request, furnish a 

copy to them. 18 

As part of the 2003 regulations, the SEC also commented on how investment advisers 

could deal with conflicts of interest related to proxy voting that might arise between 

advisers and their clicnts, stating that "an adviser could demonstrate that the vote was not 

a product of a conflict of interest if it voted client securities, in accordance with a predetermined policy, based upon the recommendations of an independent third party." 19 

In practice, this commentary provided a considerable degree of fiduciary "cover" to 

investment managcrs who chose to follow the voting recommendations of proxy advisory 

firms and reinforced the value of using such firms. In a letter to Egan-Jones Proxy 

Services in May 2004, however, the SEC articulated a duty for investment advisers to 

monitor and verify that a proxy advisor was independent and free of influence: 

An investment adviser that retains a third party to make recommendations 

regarding how to vote its clients' proxies should take reasonable steps to 

verify that the third party is in fact independent of the adviser based on all 

ofthe relevant facts and circumstances. A third party generally would be 

independent of an investment adviser if that person is free from influence 

or any incentive to recommend that the proxies should be voted in 

anyone's interest other than the adviser's clients?O 

Although the intent of the SEC's 2003 rules was to provide a flexible means 

for mutual funds to execute proxy votes in the discharge of their clients' fiduciary 

duties, in reality it allowed mutual funds to shift that duty to proxy advisory firms. 

This led then Delaware Court of Chancery Vice Chancellor Leo Strine to remark 

that "[t]he influence oflSS and its competitors over institutional investor voting 

behavior is so considerable that traditionalists will be concerned that any initiative 

to increase stockholder power will simply shift more clout to firms of this kind.,,21 

17 ld. 

18 Id. 

19Id. 

20 Letter from Douglas Scheidt, Associate Director and Chief Counsel, Sec. Exch. Comm'n, to Kent 

Hughes, Managing Director, Egan-Jones Proxy Services (May 24, 2004). 

21 Leo E. Strine Jr., Toward a True Corporate Republic: A Traditional Response to Lucian's Solutions Jor 

Improving Corporale America, Harvard Law School John M. Olin Center for Law, Economics and 

Business, Discussion Paper Series, No. 541, 11 (2006), hltp://lsr.nellco.orgiharvard _ olin/541. 

7 
46 


81762.009

IV. Conflicts ofInterest and Inaccuracies Undermine Confidence in Proxy 

Advisory Firm Processes 

Proxy advisors are currently afforded a considerable degree of deference under SEC 

interpretations because superficially they are considered "independent" of the investment 

advisors that use their services. Yet proxy advisory firms have significant conflicts of 

interest in the services they provide and in how they are structured. These conflicts have 

been the subject of two reports by the federal government's auditing arm, the U.S. 

Government Accountability Office (GAO), and they have been frequently criticized by 

companies and institutional investors. They also were the subject of questions in the 

SEC's concept release on the U.S. proxy system. 

ISS Provides "Independent" Analysis of Company Practices While Offering 

Consulting Services to Those Same Companies. Despite frequent criticism by the 

government and others over the past 16 years, ISS, the largest and most influential firm, 

continues to provide analyses and voting recommendations of proxy issues to be put to a 

shareholder vote while also providing consulting services to corporations whose 

proposals they evaluate. This led the GAO to note that "corporations could feel obligated 

to subscribe to ISS's consulting services in order to obtain favorable proxy vote 

recommendations on their proposals and favorable corporate governance ratings.,,22 

Similarly, a report by the Yale Millstein Center for Corporate Governance, stated that the 

many companies believe that "signing up for [ISS] consulting provides an advantage in 

how the firm assesses their governance" despite ISS disclaimers to the contrary. 23 

ISS also provides consulting to its institutional investor clients who wish to offer a 

shareholder proposal on how to tailor the proposal.24 

These practices have been criticized by both institutional investors and corporations 

because ISS determinations and related consulting often drive what is considered best 

practice, even if the practice may not be in the best interest of the companies or their 

shareholders. ISS acknowledges this fact in its 2012 10-K filing, stating "when we 

provide corporate governance services to a corporate client and at the same time provide 

proxy vote recommendations to institutional clients regarding that corporation's proxy 

items, there may be a perception that the Governance business team providing research to 

our institutional clients may treat that corporation more favorably due to its use of 

services provided by ISS Corporate Services.,,25 

ISS has argued that it provides a firewall between its corporate consulting and its 

advisory businesses, but the separation can only go so far. For example, ISS seeks to 

reinforce the separation by telling corporate clients that when they meet with proxy 

22 U.S. GOV'T ACCOUNTABILITY OFFICE, CORPORATE SHAREHOLDER MEETINGS: ISSUES RELATING TO 

FIRMS THAT ADVISE INSTITUTIONAL INVESTORS ON PROXY VOTING, GAO-07-765, 10 (2007). 

23 Meagan Thompson-Mann, Voting Integrity: Practice for fnvestors and the Global Proxy Advisory 

fndustry 9 (Yale Sch. of Mgmt. Millstein Ctr. for Corporate Governance & Perfonnance, Policy Briefing 

No.3, 2009). 

24 Jd. at 12. 

25 MSCI Inc. Annual Report (Fonn IO-K) at 28, March 1,2013, 

http://www.sec.gov/Archives/edgar/datalI408198/000119312513087988!d448124dlOk.htm. 

8 
47 


81762.010

analysis staff, they should refrain from discussing whether the client has received 

consulting services from the other side ofISS. That said, according to the ISS 2012 10-

K, revenucs related to its consulting businesses had grown to 25.1 percent of the total 

revenue of its governance busincss?6 

Potential Conflict Related to Proxy Advisory Firms Providing Recommendations on 

Shareholder Initiatives Backed By Their Owners or Institutional Investor Clients. Some 

proxy advisory firm c1icnts are also proponents of shareholder resolutions. According to 

the Government Accountability office, "[tJhis raises concern that proxy advisory firms 

will make favorable recommendations to other institutional investor clients on such 

proposals in order to maintain the business of the investor clients that submitted these 

proposals." 27 Other than boilerplate language, there is no specific identification that a 

shareholder proponent is an ISS client. 

Conflicts in Ownership Structures. The largest proxy advisory firms have potential 

conflicts in their ownership structures that could cast significant doubt on their 

independence, including: 

• ISS is owned by a largcr public company, MSCI, Inc., that provides a wide 

range of indices and analytics to institutional investors and corporations. The 

ownership by a larger company could result in MSCI putting pressure on ISS 

to be more favorable to certain companies to procure their business. 

• Glass, Lewis & Co. (the second largest advisor) is owned by the $100 billion 

Ontario Teachers' Pension Plan Board which engages in public and private 

equity invcsting in corporations on which Glass Lewis makes 

recommendations. Glass Lewis states that it will add a note to the research 

report of any company in which the Ontario Teachers' Pension Plan has a 

significant stake, the lack of transparency in the Glass Lewis model and the 

fact that it does not share draft reports with corporations has raised concerns 

about potential independence issues. 

The potential ramifications of a proxy advisory industry with readily recognizable 

conflicts of interest that wields great power over capital markets and the market for 

corporate governance and control, which is subject to little regulatory oversight, mirror 

those that occurred in the credit ratings agency industry before the 2008 economic 

meltdown. 

Inaccuracies in Proxy Advisory Service Reports and Lack of Transparent 

Methodologies Add to Skepticism Over Analytical Rigor In addition to questions about 

pay for performance methodologies and conflicts of interest is the problem with 

inaccuracies. This is significant because inaccurate information could lead institutional 

investors to voting decisions that are not supported by the facts. 

'61d at 8. 

27 U.S. GOV'T ACCOUNTABILITY OFFICE, CORPORATE SHAREHOLDER MEETINGS: ISSUES RELATING TO 

FIRMS THAT ADVISE INSTITUTIONAL INVESTORS ON PROXY VOTING, GAO-07-765, to (2007). 

9 
48 


81762.011

A 2010 survey ofHR Policy Association members and Center On Executive 

Compensation Subscribers - chief human resource officers of large companies -- found 

that ofthose responding, 53 percent said that a proxy advisory firm had made one or 

more mistakes in a final published report on the company's compensation programs in 

2009 or 2010. 

Very recently, it was reported that ISS made a math error in its analysis for Eagle 

Bancorp in Bethesda, Maryland. ISS said the CEO's compensation increased between 

2011 and 2012 when it actually decreased by 42 percent. ISS also double-counted some 

items in the CEO's total compensation. The company received 37 percent opposition to 

its say on pay vote, compared to 20 percent in 2012. The error was significant. Two 

institutional investors to whom Eagle spoke with changed their votes from no to yes. An 

article quoted the CEO as saying "What really upsets me more than anything else, if 

anybody had spent 10 seconds looking at the proxy, they would see that [our] proxy 

numbers are different from the ISS numbers. ISS should have asked why their numbers 

were different. ,,28 

Unfortunately, such errors are not uncommon, and it is the issuer that bears 

responsibility for checking the quality of the "expert" proxy advisory firm's assessment. 

For example, the Center is aware of another company that found a significant error by a 

proxy advisory firm. It took some time before the proxy advisory firm responded. 

Although the error was corrected and the proxy advisory finn changed the 

recommendation, the ehange was made within a week of the say on pay vote, and 

majority of shares had already been voted. The revised report made no explicit mention 

of the change on the front, and the clients would have had to review the notes at the very 

end of the report to see that the recommendation had been altered. 29 

Two principal reasons for such inaccuracies appear to be the workload pressures 

caused by the tremendous growth in the length of proxy disclosures and inadequate 

quality control, as publicly-held firms, such as ISS, seek to reduce costs by outsourcing 

proxy analysis to low labor-cost countries like the Philippines. Another reason for the 

inaccuracies is the unreasonably short time proxy advisors give large companies to 

review drafts of reports and to suggest corrections before a final report is issued. 

The implications of these inaccuracies are worth the Subcommittee's attention. ISS 

has historically recommended voting against between 30 and 40 percent of all stock plans 

it reviews. It follows that if the Center data is representative of large companies 

generally, then proxy advisory firms could be negatively impacting the compensation 

programs at a meaningful number of companies because of institutional investors' 

reliance on the data. 

The Center believes that proxy advisory firms should ensure to the greatest extent 

possible that accurate information is transmitted to institutional investors. Where 

information is found to be inaccurate, the proxy advisors should be required to correct 

28 "Eagle Bancorp: Fuzzy Math Used for Say-on-Pay Recommendation," American Banker Online, May 

31,20 13, ht1p:llwww.americanbanker.com/people/eagle-bancorp-fuzzy-math-used-for-say-on-payrecommendation-l059529-l.html?zkPrintable=true. 

29 Jd. 

IO 
49 


81762.012

their analyses and send the correction to their clients. Where there is a disagreement 

between the advisor and the company, the advisor should include a statement from the 

company discussing the rationale for its disagreement. Additionally, institutional 

investors should be required to closely monitor the output of proxy advisory firms, and 

the SEC should be required to do periodic reviews of advisor reports for accuracy and 

clarity. 

V. 2012 Peer Group Push-Back Illustrates the Effectiveness of Regulatory 

Oversight 

The Center believes that regulatory approaches to address the shortcomings discussed 

above should be carefully pursued. However, in the interim, it urges persistent and 

ongoing regulatory and legislative oversight of the proxy advisory firm industry to hold 

their policies and practices accountable and reinforce their duties to their clients and 

investors' fiduciary duties to their customers. An excellent example occurred last year 

with respect to the peer groups ISS used to determine its pay for performance 

comparisons. In many cases the peer groups did not fit with the size or industry of the 

company's business. 

For example, ISS recommended investors vote against Marriott International's say on 

pay resolution, saying that its pay should not be compared with the pay of major 

competitors such as Hyatt Hotels Corporation or Starwood Hotels, even though Marriott 

requested that these companies be included. Instead, ISS chose AutoNation, Penske 

Automotive Group, leahn Enterprises and Genuine Parts Co. as "appropriate" peers. In 

its supplemental filing, Marriott stated "we do not believe investors view these 

companies as similar in size and industry sector to our lodging management and franchise 

business. One selected peer, Penske Automotive Group, has a market capitalization that 

is less than 20 percent of Marriott's and another, leahn Enterprises LP, is not a Russell 

3000 company." 30 Ironically, the median compensation for the peer group selected for 

Starwood, a much smaller company, was more than 22 percent higher than ISS's selected 

peers for Marriott. In the end, shareholders saw through the ISS analysis and more than 

87 percent approved the Marriott say on pay resolution-much better than many other 

companies receiving a negative ISS recommendation. 

There were many other examples of companies where the peer group was a primary 

issue in the ISS say on pay recommendation and the vote as a whole. In fact, according 

to Semler Brossy Consulting Group, a majority of sUPRlemental filings (23 of 45) for the 

S&P 500 involved peer group issues, most often, ISS. I Several examples of 

questionable peers were published in business press, including three articles in the Wall 

Street Journal. 

However, the inquiries did not stop there. In our discussions with institutional 

investors last spring, several indicated that they questioned ISS's peer group selection. 

At least one indicated that they ran the peers by their portfolio managers, who also 

questioned the selections. 

30 Marrio! International, Inc., Current Report (Form 8-K) at 28, April 17, 2012, 

http://www.sec.gov/Archives/edgar/datall048286/00011931251216631I1d335747ddefa14a.htm 

31 Semler Brossy, 2012 Say on Pay Results Year-End Report, December 31, 2012, last viewed at 

http://www.semlerbrossy.com/wp-contentiup loads!20 13!0 IISB CG-SOP-Y ear-End-Report. pdf. 

II 
50 


81762.013

The attention in the popular press, by investors, and many of the groups at this table, 

led then-SEC Director of Corporation Finance, Meredith Cross to invite companies to 

send their examples to the SEC or otherwise communicate with the staff regarding 

concerns about peer groups or proxy advisory firms generally.32 The sentinel effect of 

that process reinforced the concerns in the marketplace, and ISS recognized by late spring 

that it would need to make changes to its peer group process, which it did. Although the 

Center believes that interpretive guidance or regulations from the SEC would help 

reinforce proxy advisory firm accountability, the 2012 example highlights the fact that 

targeted oversight in response to industry or investor comments can be as effective in 

addressing practices not in the best interests of shareholders and issuers. 

VI. Recommendations 

The Center believes that both non-regulatory and regulatory alternatives should be 

considered with respect to proxy advisory firms, given the power they exert over 

company practices and pay policies. However, we are concerned that a regulatory 

approach may entrench ISS and Glass Lewis and give the firms a government seal of 

approval. With these concerns in mind, we recommend the following objectives be 

pursued through oversight by Congress, the SEC and the U.S. Department of Labor. 

• Greater Ongoing Oversight of Proxy Advisorv Firm Operations. Oversight of 

proxy advisory firm policies should be subject to a regular system of oversight to 

ensure concerns from investors and issuers are met. 

• Full Disclosure of Conil icts. Financial relationships and conflicts in the proxy 

advisory industry should be made transparent to investors. Targeted conflicts 

should include significant financial or business relationships between proxy 

advisory firms, or their parent or affiliate firms and public companies, 

institutional investors or shareholder activists. Such disclosure would throw open 

to public scrutiny and academic study a wealth of information about potential 

conflicts of interest in the industry. Investors and academic researchers could 

study whether corporate shareholder votes are being "bought and sold" and the 

extent to which fees paid to proxy advisory firms are, in fact, influencing vote 

recommendations. Such scrutiny would quickly provide concrete evidence 

whether the "Chinese walls" and other safeguards the industry has instituted are 

effective in mitigating the conflicts. Proxy advisory firms that provide assistance 

to institutional investor clients sponsoring a shareholder proposal should recuse 

themselves from making a recommendation on the proposal. 

• Disclosure of Voting Methodologies. Both ISS and Glass Lewis should provide 

greater disclosure of the analytic processes, methodologies and models utilized to 

derive their voting recommendations. For instance, proxy advisory firms that 

utilize pay-for-performance compensation models to determine recommendations 

on compensation plans or advisory say on pay votes should be required to 

32 The Wall Street Journal, SEC Plans New Guidance on Proxy Advisors, June 7, 2012, 

http://blogs.w s i .coml cfo/20 12106/07 Isec-p lans-new-guidance-on -proxy-advisers! 

12 
51 


81762.014

publicly disclose all inputs, formulas, weightings and methodologies used in these 

models. Such disclosure would allow issuers and investors to effectively assess 

the merits and weaknesses of such models and to provide feedback to proxy 

advisory firms on these models. 

• SEC Monitoring of Recommendations. The SEC should implement periodic 

reviews of proxy firm research reports to check for accurately and completeness, 

much the way the SEC currently does for company filings. 

Conclusion 

The Center appreciates the opportunity to provide its views on this extremely 

important policy matter. We look forward to working with you and members of your 

staffs to ensure that the proxy voting system and advice by proxy advisory firms are 

increasingly transparent and consistent. 

13 
52 


81762.015

A Call for Change in the 

Proxy Advisory Industry Status Quo 

The Case for Greater Accountability and Oversight 

January 2011 

cll-07b 

1100 THIRTEENTH STREET I SUITE 850 

WASHINGTON DC 20005 

202.408.8181 I FAX 202.789.0064 I WWW.EXECCOMP.ORG 
53 


81762.016

About the Center On Executive Compensation 

The Ccnter On Executive Compensation is a research and 

advocacy organization dedicated to developing and promoting 

principled pay and governance practices and advocating 

compensation policies that serve the best interests of shareholders 

and other corporate stakeholders. The Center is a Division of the 

HR Policy Association, which represents the chief human resource 

officers of more than 300 of the largest corporations in the United 

States. 

Acknowledgements 

The Center On Executive Compensation would like to thank 

Scott Fenn for his considerable work as the primary researcher, 

writer and editor of this paper. His experience and expertise were 

invaluable in helping the Center staff to understand and articulate 

how the proxy advisory industry operates. That said, all 

conclusions and recommendations in the paper are the Center's 

and should not be attributable to Scott or any other individual or 

organization. 
54 


81762.017

Contents 

I. Introduction ................................................................................................................ 1 

II. Executive Summary .................................................................................................. 2 

III. The Rise of the Proxy Advisory Industry ............................................................. 14 

A. Origins of Shareholder Activism and the Proxy Advisory Industry ................... 14 

B. Increases in Institutional Stock Ownership ....................................................... 15 

C. Increases in the Volume of Proxy Votes ......................................................... 17 

D. Investors' Fiduciary Duty to Vote Proxies ........................................................ 17 

E. Academic Research Shows Proxy Advisors Have a Significant 

Impact on Voting Outcomes ............................................................................. 19 

F. Regulatory Changes Will Increase Further the Number 

and Influence of Proxy Votes ........................................................................... 21 

IV. The Proxy Advisory Firms and Their Services ................................................... 28 

A. Institutional Shareholder Services ................................................................... 28 

B. Glass, Lewis & Co ........................................................................................... 33 

C. Proxy Governance, Inc .................................................................................... 36 

D. Egan-Jones Proxy Services ............................................................................. 38 

E. Other Proxy Advisors ...................................................................................... 40 

F. Conclusion ....................................................................................................... 41 

V. Conflicts of Interest in the Proxy Advisory Industry ........................................... 42 

A. Institutional Shareholder Services Inc. (ISS) .................................................... 43 

B. Glass, Lewis & Co. . ...................................... .47 

C. Proxy Governance, Inc .................................................................................... 49 

D. Egan-Jones Proxy Services ............................................................................. 51 

E. Union-Affiliated Proxy Advisors ....................................................................... 52 

F. Parallels to Identified Conflicts at Credit Ratings Firms .................................. 52 

VI. Impact of Significant Inaccuracies and Lack of 

Transparency in Proxy Analyses ........................................................................... 55 

A. Potential Reasons for Inaccuracies .................................................................. 55 

B. Center On Executive Compensation Research on Inaccuracies .................... 58 

C. Lack of Transparency in Proxy Analyses and Recommendations .................. 60 

D. Impact of Inaccuracies and Lack of Transparency on Voting Outcomes ........ 60 

E. Conclusion ....................................................................................................... 61 
55 


81762.018

VII. The Existing Regulatory and Legal Framework for Proxy Advisors .................. 62 

A. The Investment Advisers Act of 1940 ............................................................. 62 

B. Rules Governing Proxy Solicitation .................................................................. 64 

C. Fiduciary Duty Only to Clients ......................................................................... 65 

VIII. Proposals Addressing Proxy Advisor Conflicts and 

Lack of Transparency ...........................•....................•..•...............•......•.•...•.....•...••. 67 

A. The Proxy Advisory Industry Should be Regulated by the SEC ...................... 68 

B. Proposals Contained in 2010 SEC Concept Release ...................................... 68 

C. Other Regulatory Proposals ............................................................................. 70 

D. Potential for Unintended Consequences from Enhanced 

Regulation of Proxy Advisors ....................... . ............................................... 74 

E. The Need for Effective Enforcement ................................................................ 75 

IX. Potential for Addressing the Market Power of Proxy Advisors 

Through Increased Competition ............................................................................. 76 

A. The Case for Greater Competition in the Proxy Advisory Industry ................... 76 

B. A Non-Profit Utility Model for Proxy Services ................................................... 78 

C. Mechanisms to Promote Greater Participation 

in Proxy Voting by Retail Investors .................................................................. 80 

X. The Center On Executive Compensation's Recommendations for 

Reform of the Proxy Advisory Industry .....•.... _ ....................................................... 85 

XI. Endnotes .................................................................................................................. 87 

iii 
56 


81762.019

A Call for Change in the Proxy Advisory Industry Status Quo 

I. Introduction 

Each year, institutional investors cast billions of votes that 

determine corporate directors, executive compensation and 

corporate governance policies at more than 8,000 publicly traded 

U.S. companies. By law, the institutions have a fiduciary duty to 

vote in the best interests of their clients. However, with the gaggle 

of votes they are required to make, many institutions essentially 

outsource the analysis and process of developing voting 

recommendations to a handful of third parties called proxy 

advisory finns and some firms delegate the actual proxy voting to 

such firms. With the exponential increase in institutional assets 

over the past 20 years, the proxy advisory industry has quietly 

grown extremely powerful. It exercises a considerable degree of 

influence and control over corporate governance and executive 

compensation standards and its power is concentrated with one 

firm dominating the industry. Despite its considerable clout, the 

proxy advisory industry is scarcely regulated. As a result, the 

characteristics of the industry bear an uncanny resemblance to the 

credit ratings industry before the financial crisis: 

advisory firms have considerable conflicts of interest in how 

they are structured; 

the lack of transparency of the advisory firms' analytical 

models makes it extremely difficult for investors or companies 

to determine why a proxy advisor has made certain 

determinations or to correct factual inaccuracies before a vote 

is held; and 

concerns have mounted that inaccurate information is being 

transmitted to investors and all this is happening just as the 

influence of the industry is poised to increase as a result of 

changes in the just-passed financial reform hill. 

The purpose ofthis paper is to provide essential background 

information on the development of the proxy advisory industry, 

expose the conflicts of interest and procedural lapses that could 

result in inaccurate proxy votes, review regulatory approaches to 

date, and suggest a workable approach to regulation of the 

industry. 

@2011 Center On Executive Compensation 
57 


81762.020

A Call for Change in the Proxy Advisory Industry Status Quo 

II. Executive Summary 

Over thc last quarter century, a confluence of developments has 

served to aggregate tremendous power among a small group of 

proxy advisory finns. These factors include: 

An increase in institutional stock ownership of the 1,000 

largest corporations from 47 percent in 1987 to 76 percent in 

2007, thus concentrating voting power in institutions, rather 

than retail investors. 

With this increase in institutional investor ownership has come 

an increase in ownership by state pension funds, which tend to 

be more progressive in their activism and frequently rely more 

heavily on the recommendations of proxy advisors. 

Increases in the volume of proxy votes, as the SEC expanded 

the subjects on which it pennitted shareholder proposals and 

the growth of equity indexing. These changes required 

institutions to develop a voting position on more issues. 

Reflecting this growth, Broadridge Financial Solutions 

reported a 14 percent increase in the number of shares it 

processed between 2009 and 2010, from 309 billion shares to 

350 billion shares processed. 

Regulatory mandates that pension funds and other institutional 

investors have a fiduciary duty to vote their proxies in the best 

interest of their clients. A 1988 Department of Labor 

interpretive letter reinforced this requirement with respect to 

pension funds, and a 2003 SEC rulemaking reinforced the 

requirement with mutual funds and investment advisors. 

A 2003 SEC interpretation that indicated that investment 

advisors could discharge their duty to vote their proxies and 

demonstrate that their vote was not a product of a conflict of 

intercst if they voted client securities in accordance with a predetennined pol icy and based on the recommendations of an 

independent third party (e.g., a proxy advisory finn). 

The expansion of proxy voting, along with the regulatory 

interpretations, have caused the vast majority of institutional 

investors to separate the individuals making investment decisions 

from those making proxy voting decisions. As a whole, this has 

increased the influence of proxy advisory finns since institutional 

investors rely to a much greater extent on proxy advisors' analyses 

and voting recommendations. 

©2011 Center On Executive Compensation 2 
58 


81762.021

A Call for Change in the Proxy Advisory Industry Status Quo 

Academic Research Shows Proxy Advisors Wield 

Exceptional Clout 

The market for proxy adv isory services has developed in such a 

way that one firm, Institutional Shareholder Services (ISS), largely 

controls the market, with a 61 % market share, 1 and a second, 

Glass, Lewis & Co. controls approximately 37% of the market? 

This concentration has allowed the firms to have a significant 

impact on pay and governance policy. For example, with regard to 

ISS, the dominant proxy advisory firm, academic research has 

shown that: 

a negative recommendation on a management proposal can 

reduce the support of institutional investors by up to 20 

percen!,3 causing ISS to be the de/acto pay and governance 

police and 

ISS's vote recommendations in contested director elections are 

"good statistical predictors of contest outcomes," in part 

because they influence investors to revise their assessment of 

board nominees 4 

The academic research on the influence of proxy advisors is 

bolstered by evidence from firms that closely monitor institutional 

voting. 

Recent statistics from the proxy solicitation firm lnnisfree 

M&A, for instance, found that ISS clients typically control 20 to 

30 percent of a midcap or largecap company's outstanding shares, 

while Glass Lewis clients typically control 5 to 10 percent.s The 

primary reason for the influence of these firms is simple: under 

SEC interpretations the advisory firms are considered independent 

experts, and if institutional investors rely on the recommendations 

made by them, they are held to have discharged their fiduciary 

duties to vote in the investors~ best interests. Reflecting this point, 

the Honorable Leo E. Strine, Jr., Vice Chancellor of the Delaware 

Court of Chancery, commented that "the influence of ISS and its 

competitors over institutional investors' voting behavior is so 

considerable that traditionalists will be concerned that any 

initiative to increase stockholder power will simply shift more 

clout to firms of this kind." 

The level of influence wielded by proxy advisors on 

compensation issues was highlighted by a recent survey of 251 

companies by consulting firm Towers Watson, which found that 59 

percent of respondents believed that proxy advisors have 

significant influence on executive pay decision-making processes 

at U.S. companies. Similar results were obtained in a 2010 survey 

©2011 Center On Executive Compensation 3 
59 


81762.022

A Call for Change in the Proxy Advisory Industry Status Quo 

by the Center On Executive Compensation, where 54 percent of 

survey respondents said they had changed or adopted a 

compensation plan, policy or practice in the past three years 

primarily to meet the standards of a proxy advisory firm. 

Influence of Proxy Advisors Will Increase With the 

Adoption of Say on Pay and Other Policy Changes 

The executive compensation and corporate governance 

provisions in the Dodd-Frank Act, the new financial reform law, 

will have the unintended consequence of further increasing the 

power and influence of proxy advisory firms. This is particularly 

the case with "say on pay" -- the new requirement that 

shareholders have a periodic nonbinding vote on executive 

compensation at least once every three years. This requirement 

will substantially increase the number of proxy votes on ballots 

annually and cause many institutional investors to defer to the 

proxy advisory firms' analysis as to whether a company's 

executive compensation program should be supported or opposed. 

Although institutional investors may have custom proxy voting 

policies, the basis for many, if not most, of these policies is the 

advisory firms' base policies. Without a viable alternative in the 

marketplace, the advisors' recommendations will determine 

whether a say on pay vote obtains substantial support. 

This concern has been echoed by many different 

commentators, including: 

Former T1AA-CREF General Counsel and Current Governance 

for Owners U.S. Chairman, Peter Clapman, who indicated "the 

inevitable consequence [of adopting say on pay] would be to 

transfer considerable discretionary power over individual 

company compensation practices to the proxy advisory firms. I 

question that such an approach will serve the long-term best 

interests of shareholders." 

Edward Durkin, Director of Corporate Affairs for the 

Carpenters Union: "If you have an annual say on pay vote and 

you exercise your voting responsibility as we do ... it'd be 

overwhelming," said Durkin, whose union owns stakes in 

3,500 companies.6 

Columbia Law Professor Jeffrey Gordon, who indicated that 

"the burden of annual voting would lead investors, particularly 

institutional investors, to farm out evaluation of most pay plans 

to a handful of proxy advisory firms who themselves will seek 

to economize on proxy review costS.',7 

©2011 Center On Executive Compensation 4 
60 


81762.023

A Call for Change in the Proxy Advisory Industry Status Quo 

In addition, because Dodd-Frank also requires shareholders to 

vote on how frequently a say on pay vote will occur - everyone, 

two or three years proxy advisors have a built-in preference to 

hold advisory votes every year because of the reliance that 

institutional investors will place on their analyses. Prior to the 

adoption of Dodd-Frank, the ISS methodology expressed a 

preference for an annual say on pay vote, and if a company's 

compensation plan conflicted with its policies, ISS indicated that it 

would recommend against the pay plan. It also stated "if there is 

no MSOP on the ballot, then the negative vote will apply to 

members of the compensation committee." ISS has confinned that 

it will use this approach in the 20 II proxy season, even though the 

law clearly allows shareholders to express their preferences for a 

biennial or triennial say on pay vote. 

The proxy advisors will also have significant influence over the 

say on pay vote required on change-in-control payments in merger 

and acquisition situations, which is required by Dodd-Frank. 

A numher of other changes in the Dodd-Frank Act are likely to 

increase the influence of the proxy advisory finns. These include: 

Elimination of Broker Discretionary Voting. Broker-dealers 

historically had the ability to vote their clients' shares, if the 

broker did not have specific voting instructions from the client. 

Broker discretionary votes have typically been cast in favor of 

management and can comprise up to 20 percent of the votes at 

some companies. However, without a significant increase in 

retail voter participation, it is unlikely that those shares will be 

voted at all, effectively disenfranchising a significant subset of 

shareholders and increasing the influence of institutional 

shareholders and thus the proxy advisory finns. 

Proxy Access for the Nomination of Directors. The DoddFrank Act gave the SEC authority to promulgate a rule 

al10wing certain shareholders to nominate candidates to a 

company's board of directors, and the SEC approved such a 

rule roughly one month after Dodd-Frank became law. The 

validity ofthe rule is being challenged in federal court, and its 

implementation has been suspended pending the court's ruling. 

However, ifthe rule is ultimately upheld, the long-tenn impact 

will be to increase the number of contested elections on which 

institutional investors need to vote. As one organization of 

corporate pension plan sponsors commented, "these new proxy 

access standards will give [the proxy advisory finns 1 even 

greater power over the election of the boards of directors."s 

©2011 Center On Executive Compensation 5 
61 


81762.024

A Call for Change in the Proxy Advisory Industry Status Quo 

Without greater oversight of the proxy advisory firms from the 

SEC and institutional investors, these changes will have a 

measurable impact on the influence the proxy advisors wield over 

the proxy process to the detriment of retail investors. 

The Impact of Majority Voting for Directors. Another 

important change that has increased the influence of proxy 

advisory finns over institutional investors is the change from 

plurality voting for directors to majority voting for directors. Since 

2004, amendments to the Model Business Corporation Act, 

Delaware General Corporation Law and shareholder campaigns 

have helped facilitate the adoption of majority voting for directors, 

with over two-thirds of companies in the S&P 500 Index using 

majority voting. Under majority voting, a candidate must receive a 

majority of votes cast in order to be elected, and thus a candidate in 

an uncontested election receiving less than a majority of votes cast 

is not considered elected. This contrasts with the historic practice 

of plurality voting for directors, in which the director to receive the 

most votes, without regard to withheld votes, won. With majority 

voting, recommendations from proxy advisory finns to withhold a 

vote or vote against a director could result in the failure to get 

elected. 

The influence of the proxy advisors under majority voting is 

considerable and, in many cases, the recommendation to vote for 

or against a director is based upon the finns' analysis of the 

company's compensation and governance practices. It is therefore 

important that the advisors' policies and methodologies used for 

analyzing company practices be free from conflicts, errors, be 

transparent and be based upon sound compensation and 

governance understanding, which is regularly not the case. 

The advent of majority voting provides shareholders and proxy 

advisors with a strong tool to hold directors accountable. 

However, before they can do so in a fashion that is in the best 

interests of shareholders and the proxy voting system as a whole, 

the advisors must be held accountable for the conflicts of interest 

and inaccuracies in analysis that are all too common. 

©2011 Center On Executive Compensation 6 
62 


81762.025

A Call for Change in the Proxy Advisory Industry Status Quo 

Conflicts of Interest at the Largest Advisory Firms Cast 

a Shadow on the Integrity of Research and Voting 

Recommendations 

Proxy advisors are currently afforded a considerable degree of 

deference under SEC interpretations because superficially they are 

considered "independent" of the investment advisors that use their 

services. Yet proxy advisors have significant conflicts of interest 

that raise serious questions about their independence. The largest 

proxy advisory firms have significant conflicts of interest in the 

services they provide and in how they are structured. These 

conflicts have been the subject of two reports by the federal 

government's auditing arm, the U.S. Government Accountability 

Office (GAO), and they have been frequently criticized by 

companies and institutional investors. 

ISS Provides "Independent" AnalysiS of Company 

Practices While Offering Consulting Services to Those Same 

Companies. Despite frequent criticism by the government and 

others over the past 16 years, ISS, the largest and most influential 

firm, continues to provide analyses and voting recommendations of 

proxy issues to be put to a shareholder vote while also providing 

consulting services to corporations whose proposals they evaluate. 

This led the GAO to note that "corporations could feel obligated to 

subscribe to ISS's consulting services in order to obtain favorable 

proxy vote recommendations on their proposals and favorable 

corporate governance ratings.,,9 Similarly, a report by the 

Millstein Center On Corporate Governance, stated that the many 

companies believe that "signing up for [ISS) consulting provides 

an advantage in how the firm assesses their governance" despite 

ISS disclaimers to the contrary.1O 

Corporate governance expert Ira Millstein described the 

inherent conflict in the ISS model as follows: 

It provides structural "standards" for corporate governance, 

privately prepared by unidentified people. pursuant to 

unidentified processes, and asks us to take its word that it is 

all fair and balanced. I tried to dig behind the soothing 

assurances, but couldn't find enough detail to convince me 

that a devil didn't lie in the details of how this private 

standard-setting was put together. And then ISS provides 

company ratings, based on these privately-set standards, 

creating a tendency on the part of those that have received a 

poor rating to pay for a consultancy by the private standardsetter, on how to improve tbat rating. I see this as a vicious 

cycle. 

©2011 Center On Executive Compensation 7 
63 


81762.026

A Call for Change in the Proxy Advisory Industry Status Quo 

This "vicious cycle" has been roundly criticized by both 

institutional investors and corporations because ISS detenninations 

and related consulting drives what is considered best practice, evcn 

if the practice may not be in the best interest of the companies or 

their shareholders. Even ISS acknowledges this fact in its 2009 

I O-K filing, stating "for example, when we provide corporate 

governance services to a corporate client and at the same time 

provide proxy votc recommendations to institutional clients 

regarding that corporation's proxy items, there may be a perception 

that we may treat that corporation more favorably due to its use of 

our services, including our Compensation Advisory Services, 

provided to certain corporate clients."" 

ISS has argued that it provides a firewall between its corporate 

consulting and its advisory businesses, but the separation can only 

go so far. For example, ISS seeks to reinforce the separation by 

telling corporate clients that when they meet with proxy analysis 

staff, they should refrain from discussing whether the client has 

received consulting services from the other side oflSS. 

Conflicts in Ownership Structures. The largest proxy 

advisory firms have potential conflicts in their ownership 

structures that could cast their independence into significant doubt, 

including: 

ISS is owned by a larger public company, MSCI, Inc., that 

provides a wide range of services to institutional investors and 

corporations. The ownership by a larger company could result 

in MSCI putting pressure on ISS to be more favorable to 

certain companies to procure their business. Glass, Lewis & 

Co. (the second largest advisor) is owned by the Ontario 

Teachers' Pension Plan which engages in public and private 

cquity investing in corporations on which Glass Lewis makes 

recommendations. Although Glass Lewis states that it will add 

a note to the research report of any company in which the 

Ontario Teachers' Pension Plan has a significant stake, the lack 

of transparency in the Glass Lewis model and the fact that it 

does not share draft reports with corporations has raised 

concerns about potential independence issues; 

As Julie Gozan, Director of Corporate Governance at unionowned Amalgamated Bank, commented: "The community that 

relies on Glass Lewis and ISS needs to know this is unbiased 

advice that favors long-tenn investors and not the interests of 

corporate executives. When these finns go public, there's real 

potential for a conflict of interest.,,12 The conflicts of interests are 

not unique to the large finns, however. For example: 

©2011 Center On Executive Compensation 8 
64 


81762.027

A Call for Change in the Proxy Advisory Industry Status Quo 

Proxy Governance Inc., (the third largest proxy advisory finn 

until the end of201O) was owned by a firm whose chief 

subsidiary is a registered broker-dealer, which could lead to 

divergent interests among clients of each firm; 

Egan-Jones is owned by a finn whose primary business is a 

credit ratings agency; and 

Marco Consulting, a proxy advisor whose clients are TaftHartley pension funds, may find itself pressured to recommend 

in favor of a shareholder proposal submitted by a client, even if 

contrary to its voting guidelines, to retain the client. 

The potential ramifications of a proxy advisory industry with 

readily recognizable conflicts of interest that wields great power 

over capital markets and the market for corporate governance and 

control, which is subject to little regulatory oversight, mirror those 

that occurred in the credit ratings agency industry before the 2008 

economic meltdown. These include: the existence of a quasiregulatory license, conflicts of interest in the business model and 

the provision of ancillary services, and insufficient regulation. 

Ultimately, this caused Congress to establish a new regulatory 

framework for the credit ratings industry in the Dodd-Frank Act. 

The Center believes that, at a minimum, the SEC should ban 

conflicts of interest in the proxy advisory finn industry in which a 

finn both provides so-called "independent" analyses of company 

practices for institutional investors while simultaneously offering 

consulting services to companies as to how to improve the 

company's assessment by the advisor. The Center also believes 

that the SEC should require greater disclosure of other conflicts, 

especially those created by the ownership structures of proxy 

advisory finns. 

Inaccuracies in Proxy Advisory Service Reports and 

Lack of Transparent Methodologies Add to SkeptiCism 

Over Analytical Rigor 

In addition to conflicts of interest, anecdotal infonnation and 

survey data raise significant questions regarding whether there are 

increasing inaccuracies among the analyses published by the proxy 

advisory finns. This is significant because inaccurate infonnation 

could lead institutional investors to voting decisions that are not 

supported by the facts. 

©2011 Center On Executive Compensation 9 
65 


81762.028

A Call for Change in the Proxy Advisory Industry Status Quo 

A 2010 survey of HR Policy Association members and Center 

On Executive Compensation Subscribers - chief human resource 

officers oflarge companies -- found that of those responding, 53 

percent said that a proxy advisory firm had made one or more 

mistakes in a final published report on the company's 

compensation programs in 2009 or 2010. 13 The three most 

frequent types of inaccuracies identified by companies included: 

improper use of peer groups or peer group data in determining 

whether executive compensation levels were appropriate which 

was reported by 20 percent of respondents; 

erroneous analysis of long-term incentive plans reported by 17 

percent of respondents; and 

inaccurate discussion of provisions no longer in effect was 

reported by 15 percent of respondents. 

Two principal reasons for such inaccuracies appear to be the 

workload pressures caused by the tremendous growth in the length 

of proxy disclosures and inadequate quality control, as publiclyheld firms, such as ISS, seek to reduce costs by outsourcing proxy 

analysis to low labor-cost countries like the Philippines. Another 

reason for the inaccuracies is the unreasonably short time proxy 

advisors give companies to review drafts of reports and to suggest 

corrections before a final report is issued. 

The implications of these inaccuracies are alarming. ISS has 

historically recommended voting against between 30 and 40 

percent of all stock plans it reviews. It follows that if the Center 

data is representative of large companies generally, then proxy 

advisory firms are negatively impacting the compensation 

programs at a meaningful number of companies because of 

institutional investors' reliance on the data. 

The Center believes that proxy advisory firms should ensure to 

the greatest extent possible that accurate information is transmitted 

to institutional investors. Where information is found to be 

inaccurate, the proxy advisors should be required to correct their 

analyses and send the correction to their clients. Where there is a 

disagreement between the advisor and the company, the advisor 

should include a statement from the company discussing the 

rationale for its disagreement. Additionally, institutional investors 

should be required to closely monitor the output of proxy advisory 

firms, and the SEC should be required to do periodic reviews of 

advisor reports for accuracy and clarity. 

©2011 Center On Executive Compensation 10 
66 


81762.029

A Call for Change in the Proxy Advisory Industry Status Quo 

The Extent of Government Regulation Over the Proxy 

Advisory Industry Is Inadequate Given Its Influence Over 

the Proxy Voting Process 

Proxy advisory firms are currently "regulated" by the SEC 

under the Investment Advisers Act of 1940, a statute written 

principally for firms that provide investment advice to companies 

or individuals. Various exemptions under the Act mean that proxy 

advisory firms can essentially choose whether to register with the 

SEC under the Act, and while additional regulatory and procedural 

requirements apply to those that do, the statute has been lightly 

enforced with respect to proxy advisors. Institutional investors, for 

their part, have seen proxy advisors as a cost-effective and efficient 

way to discharge and essentially outsouree their own duties for 

voting proxies. Therefore, they have little incentive to change the 

system by closely monitoring the decisions and pointing out 

deficiencies in the quality controls of proxy advisors. 

Proposals for Increased Oversight of the Proxy Advisory 

System Take a Step in the Right Direction 

A number of proposals have been made to tighten regulation of 

the industry - ranging from mandating greater disclosure under 

existing rules to imposing new regulatory frameworks similar to 

those that apply to credit ratings agencies or public accounting 

firms. The new regulatory frameworks include requiring greater 

transparency of methodologies and filing voting recommendations 

with the SEC on a dclayed basis, much like the mutual fund 

industry must currently file its proxy votes. These proposals are 

under consideration by the SEC, which requested public comment 

on the deficiencies in the proxy advisory firm industry and 

recommendations on how to address them. The Department of 

Labor went one step further in October 20 lO, by proposing 

regulations that would arguably impose ERISA fiduciary status on 

SEC-registered proxy advisory firms and possibly all proxy 

advisory firms. Many of these proposals have significant merit. 

However, there are also legitimate concerns that regulation could 

havc unintended consequences - serving to credential and entrench 

existing proxy firms while creating barriers to entry for new firms. 

©2011 Center On Executive Compensation 11 
67 


81762.030

A Call for Change in the Proxy Advisory Industry Status Quo 

Fostering Greater Competition in the Proxy Advisory 

Industry May Address Fundamental Problems 

Proposals have been made to adopt a public utility model for 

the widespread provision of proxy recommendations or to develop 

client-directed voting platforms to enhance retail voting 

participation. If successful, such efforts have the potential to dilute 

the influence of proxy advisors by expanding the market for 

services providing expert voting recommendations. To be 

effective, such approaches would need to provide 

recommendations that institutional investors could rely on to assist 

in discharging their fiduciary duty to vote their proxies in the best 

interests of their clients. 

Center Recommends Banning Worst Conflicts and 

Requiring BeHer Disclosure to Promote Market Reforms 

The Center On Executive Compensation believes that the most 

effective approach for mitigating the issues surrounding the proxy 

advisory services involves the following basic reforms. 

Ban on Worst Form of Conflict. The SEC should institute a 

ban on proxy advisory firms, or their affiliates, from providing 

advisory services to institutional investors, while at the same time 

providing consulting services to corporate issuers on matters 

subject to proxy votes. Pending the change, mandate disclosure by 

companies of the fees paid and services obtained from proxy 

advisors in the proxy statement. 

Full Disclosure of Other Conflicts. The SEC should 

mandate disclosures designed to make other financial relationships 

and conflicts in the proxy advisory industry transparent to 

investors. Targeted conflicts should include significant financial 

or business relationships between proxy advisory firms. or their 

parent or affiliate firms, with public companies. institutional 

investors or shareholder activists. Such disclosure would throw 

open to public scrutiny and academic study a wealth of information 

about potential conflicts of interest in the industry. Investors and 

academic researchers could study whether corporate shareholder 

votes are being "bought and sold" and the extent to which fees paid 

to proxy advisory firms are, in fact. influencing vote 

recommendations. Such scrutiny would quickly provide concrete 

evidence whether the "Chinese walls" and other safeguards the 

industry has instituted are effective in mitigating the conflicts. 

Disclosure of Voting Methodologies. The SEC should also 

mandate that proxy advisory firms disclose the analytic processes, 

methodologies and models utilized to derive their voting 

©2011 Center On Executive Compensation 12 
68 


81762.031

A Call for Change in the Proxy Advisory Industry Status Quo 

recommendations. For instance. proxy advisory firms that utilize 

pay-for-performance compensation models to determine 

recommendations on compensation plans or advisory say on pay 

votes should be required to publicly disclose all inputs, formulas, 

weightings and methodologies used in these models. Such 

disclosure would allow issuers and investors to effectively assess 

the merits and weaknesses of such models and to provide feedback 

to proxy advisory firms on these models. 

Clarity Fiduciary Duties of Institutional Investors and Plan 

Sponsors. The SEC should provide additional guidance to 

investment advisers and plan sponsors making it clear that their 

fiduciary obligations to vote proxies in the interests of investors 

require diligent monitoring of the conflicts, practices and decision 

processes of third-party proxy advisors. The mere act of hiring a 

proxy advisor should not be seen as sufficient to allow institutions 

to meet their fIduciary obligations under ERISA. Moreover, these 

obligations should be vigorously enforced to provide a true 

incentive for institutions to take seriously their role in monitoring 

and influencing proxy advisory firm behaviors and policies. 

SEC Monitoring of Recommendations. The SEC should 

implement periodic reviews of proxy firm research reports to 

check for accurately and completeness, much the way the SEC 

currently does for company filings. 

This paper examines the above issues in depth. Chapter III 

discusses the historical factors that have concentrated voting power 

in the hands of proxy advisors leading to a near-monopoly in the 

industry - and why recent financial regulatory developments will 

increase this power further. Chapter IV provides background on 

each of the proxy advisory firms and the services they provide. 

Chapter V explains the types of conflicts of interest that proxy 

advisory firms are subject to and how those conflicts parallel those 

which have engendered so much concern at credit ratings agencies. 

Chapter VI discusses concerns about the lack of transparency and 

inaccuracies in proxy analyses and presents survey research on 

these inaccuracies as they relate to compensation issues. Chapter 

VII outlines the existing regulatory and legal framework for proxy 

advisory firms. Chapter VIII discusses proposals for addressing 

problems in the industry through increased regulation as well as 

some concerns about potential unintended consequences from this 

approach. Chapter IX examines the potential for greater 

competition and other private sector solutions as mechanisms for 

addressing problems at proxy advisors. Chapter X summarizes 

the Center's recommendations. 

©2011 Center On Executive Compensation 13 
69 


81762.032

A Call for Change in the Proxy Advisory Industry Status Quo 

III. The Rise of the Proxy Advisory 

Industry 

The proxy advisory industry is receiving considcrablc scrutiny 

because, over the last three decadcs, it has grown to play an 

increasingly influential role in the U.S. and global proxy voting 

system - the principal means by which shareholders of 

corporations participate in corporate governance. That influence is 

poised to expand considerably in 20 II, when each public company 

is required to hold a nonbinding shareholder vote on executive 

compensation. 

The growing influence ofthe small number of finns providing 

proxy research and voting recommendations has been driven by 

tremendous growth in share ownership by institutional investors as 

well as the number of ballot items that institutions must vote on 

each year. From May 1,2009, through April 30, 2010, for 

example, nearly I trillion shares were votcd at more than 13,800 

U.S. corporate issuers.14 Going forward, recent important changes 

in regulations governing the financial industry, corporate 

governance and proxy voting seem destined to further increase the 

reliance of institutional investors on proxy advisors. 

To understand the effect of these changes on the growth in 

influence of proxy advisory firms, it is important to understand the 

origins of the industry and how the growth in institutional assets 

has shaped it with relatively little federal oversight. 

A. Origins of Shareholder Activism and the Proxy 

Advisory Industry 

Shareholder activism has been around for over 400 years, 

dating back to a petition lodged against the Dutch East India 

Company by investor Isaac Le Maire." In the United States, 

financial institutions, such as banks and mutual funds, were 

"activist" investors at many corporations in the early 1900s, with 

representatives of these financial institutions often serving on 

corporate boards and becoming involvcd in the strategic direction 

of the finn. 16 Modern U.S. shareholder activism is often traced to 

the 1942 adoption by the Securities and Exchange Commission of 

a shareholder proposal rule, granting shareholders the right to 

submit certain types of proposals for inclusion on corporate proxy 

ballots. I? 

©2011 Center On Executive Compensation 14 
70 


81762.033

A Call for Change in the Proxy Advisory Industry Status Quo 

Individual Investor Activism Predominated Until the Late 

19805. Early U.S. shareholder activism was dominated by 

individual investors who were often labeled "gadflies." In 1982. 

for example, nearly 30 percent of the 972 shareholder proposals 

submitted to companies were proposed by just three individuals. 18 

Use of the shareholder proxy process by institutional investors 

began to grow in the mid-1980s, however, after the 1985 founding 

of the Council of Institutional Investors, originally a group of 

public and union pension funds interested in lobbying for greater 

shareholder rights. 

Proxy Research Initiated by College Endowments Then 

Spread to Institutional Investors. The need for professional 

proxy research and analysis by institutional investors first 

manifested itself in the formation of the Investor Responsibility 

Research Center (lRRC) in 1972. IRRC was founded by a group 

of college and university endowments and foundations who wanted 

impartial research on social and environmental questions raised in 

proxy proposals. Later, in the early 1980s, as activists began to 

expand their use of shareholder proposals, IRRC expanded its 

services to include research on corporate governance issues and an 

electronic voting platform and soon had hundreds of institutional 

investors subscribing to its services. IRRC was organized as a notfor-profit corporation and, while it provided research reports on 

specific ballot items, it did not make vote recommendations. 

Proxy voting recommendations were introduced to the market 

in mid-1980s with tbe founding of two private commercial 

companies - Proxy Monitor in 1984 and Institutional Shareholder 

Services (ISS) in 1985. These firms satisfied a demand from many 

institutional investors for proxy analyses that contained voting 

recommendations. Over time, ISS became an industry 

consolidator by buying or merging with several rival firms, 

including Proxy Monitor (in 200 I) and IRRC (in 2005). Three 

other commercial proxy advisory firms soon entered the market to 

compete with ISS, with Glass, Lewis & Co. and Egan-Jones Proxy 

Services offering services in 2003, and Proxy Governance, Inc. 

launching a service in 2005. 

B. Increases in Institutional Stock Ownership 

Dramatic changes in the nature of equity ownership in the 

United States in the last half century have largely created the 

demand for proxy advisory services. Institutional investors 

including pension funds, investment companies, mutual funds, 

insurance companies, hedge funds, banks, foundations and 

endowments - have greatly increased their ownership share of 

public companies relative to individual invcstors. At the end of 

©2011 Center On Executive Compensation 15 
71 


81762.034

A Call for Change in the Proxy Advisory Industry Status Quo 

2007, levels of institutional stock ownership of the 1,000 largest 

corporations in the U.S. reached an all-time high of 76.4 percent, 

according to the Conference Board, up from an average of 61.4 

percent in 2000 and 46.6 percent in 1987. 19 

Meanwhile, the percentage of equity shares held by retail 

investors has fallen to new lows, accounting for less than 24 

percent of shares in the 1,000 largest corporations at the end of 

2007, compared with 94 percent of all stocks in 1950, and 63 

percent in 198020 The impact of this decline in retail share 

ownership on voting is amplified by declining retail investor 

voting participation. 

State and Local Pension Funds Fuel Equity Asset Growth 

and Activism. Among categories of institutional investors, the 

growth of equity assets under management by state and local 

public pension funds is important because these funds tend to be 

more progressive in their activism and frequently rely heavily on 

the recommendations of proxy advisors. According to Conference 

Board data, public pension funds increased their share of total 

equity assets from 2.9 percent in 1980 to 10 percent by the end of 

2006, while private, trusteed funds (generally corporate pension 

plans) saw their share oftotal equity assets decline from 15.1 

percent in 1980 to 13.6 percent in 200621 

The dramatic growth in U.S. institutional ownership of 

corporate equities between 1985 and 2005 is illustrated below in 

Figure I. 

FIGURE 1: 

I U.S. Institutional OWne~ip inc~rate Equities 

i 10.0 $ in trillions 

B.O 

6.0 

4.0 

2.0 

1985 1995 200S 

©2011 Center On Executive Compensation 16 
72 


81762.035

A Call for Change in the Proxy Advisory Industry Status Quo 

C. Increases in the Volume of Proxy Votes 

At the same time that equity assets held by institutional 

investors were burgeoning, the volume of proxy votes that many 

institutions needed to process grew tremendously, Proxy voting 

volumes were increasing due to several factors. An increase in the 

number of shareholder activists resulted in an increase in 

shareholder proposals due in part to changes in SEC rules 

expanding subjects that proposals could address. In addition, the 

growth of equity indexing meant that by the 1980s, many 

institutions began to hold thousands of equity securities in their 

portfolios, as opposed to the few hundred typically owned by 

"'active" investment managers.22 

The tremendous growth in proxy voting in recent decades 

shows little evidence of slowing down. During the 20 I 0 proxy 

season (Feb. 15 - May I), Broadridge Financial Solutions, the 

primary proxy vote processing finn, reported that it processed over 

350 billion shares, up nearly 14 percent from over 308 billion in 

2009.23 

D. Investors' Fiduciary Duty to Vote Proxies 

After the passage of the Employee Retirement Income 

Securities Act of 1974 (ERISA), the U.S. Department of Labor 

(DOL) began requiring private pension fund fiduciaries to act 

solely in the interests of their plan participants and beneficiaries. 

Subsequently, in 1988, DOL released a letter, commonly known as 

the "A von Letter," stating that shareholder voting rights were 

considered valuable plan assets under ERISA, and therefore the 

fiduciary duties of loyalty and prudence applied to proxy voting. 

The Avon Letter stated: 

[n general, the fiduciary act of managing plan assets which 

are shares of corporate stock would include the voting of 

proxies appurtenant to those shares of stock. For example, it 

is the Department's position that the decision as to how 

proxies should be voted ... are fiduciary acts of plan asset 

management?1 

The A von Letter further stated that pension fund fiduciaries, 

including those that delegated proxy voting responsibilities to their 

investment managers, had a responsibility to monitor and keep 

accurate records of their proxy voting.25 

The SEC further reinforced the concept of fiduciary duties 

related to proxy voting in 2003 by adopting a rule and amendments 

under the Investment Advisers Act of 1940 pertaining to mutual 

funds and investment advisers26 The new regulations required 

©2011 Center On Executive Compensation 17 
73 


81762.036

A Call for Change in the Proxy Advisory Industry Status Ouo 

mutual funds to: I) disclose their policies and procedures related to 

proxy voting and 2) tile annually with the Commission a public 

report on how they voted on each proxy issue at portfolio 

companies. 

Similarly, investment advisers were required to: 1) adopt 

written proxy voting policies and procedures describing how the 

adviser addressed material conflicts between its interests and those 

of its clients with respect to proxy voting and how the adviser 

would resolve those conflicts in the best interests of clients; 2) 

disclose to clients how they could obtain information from the 

adviser on how it had voted proxies; and 3) describe to clients all 

proxy voting ~olicies and procedures and, upon request, furnish a 

copy to them. 7 

As part of the January 2003 regulations, the SEC also 

commented on how investment advisers could deal with conflicts 

of interest related to proxy voting that might arise bctween advisers 

and their clients, stating that "an adviser could demonstrate that the 

vote was not a product of a conflict of interest if it voted client 

securities, in accordance with a pre-determined policy, based upon 

the recommendations of an independent third party."" In practice, 

this commentary provided a considerable degree of fiduciary 

"cover" to investment managers who chose to follow the voting 

recommendations of proxy advisory firms and reinforccd the value 

of using such firms. In a letter to Egan-Jones Proxy Services in 

May 2004, however, the SEC articulated a duty for investment 

advisers to monitor and veritY that a proxy advisor was 

independent and free of influence: 

An investment adviser that retains a third party to make 

recommendations regarding how to vote its clients1 proxies 

should take reasonable steps to veritY that the third party is 

in fact independent orthe adviser based on all of the relevant 

facts and circumstances. A third party generally would be 

independent of an investment adviser if that person is free 

from influence or any incentive to recommend that the 

proxies should be voted in anyone's interest other than the 

adviser's clients. 29 

There remain serious concerns by some observers and 

regulators whether institutional managers are meeting their 

fiduciary duties with regard to proxy voting. For example, in two 

articles published in the Latham & Watkins LLP's Corporate 

Governance Commentary, Charles Nathan, co-chair of the firm's 

Corporate Governance Task Force, argues that the bifurcation that 

has occurred in the market between investment decision-makers 

and those responsible for proxy voting may not meet fiduciary 

standards:3o 

©2011 Center On EXGcutive Compensation 16 
74 


81762.037

A Call for Change in the Proxy Advisory Industry Status Quo 

The effectiveness of this model rests on the assumption that voting 

decisions can be deJegated to specialists and third-party proxy 

advisors so as to fulfill the institution's fiduciary duties without 

imposing undue costs on the institution. It is not clear, however, 

that the parallel voting universe that has evolved over the past 25 

years successfully discharges institutional investors' fiduciary 

duties of due care and loyalty. 31 

Although historically there has been very little SEC 

enforcement regarding fiduciary duties with respect to proxy 

voting, in recent years, the SEC has begun to show interest in the 

issue. In 2008, it issued a Compliance Alert letter that described 

some of the deficiencies it found in managers' proxy voting 

oversight and operations.32 Then, in May 2009, it settled an 

enforcement action against an investment adviser and its Chief 

Operating Officer related to that adviser's proxy policies, 

procedures and failure to disclose to clients a material conflict of 

interest related to those policies.)) In July 2010, the SEC asked for 

public comment on a concept release asking whether rules changes 

in the U.S. proxy system should be considered to promote greater 

efficiency and transparency.)4 Finally, in September 2010, the 

New York Stock Exchange Commission on Corporate Governance 

issued its final report which contained governance principles 

calling for proxy advisory firms to be held to appropriate standards 

of transparency and accountability and for institutional investors to 

vote their shares in a thoughtful manner and avoid a '''check the 

box mentality. ",35 

E. Academic Research Shows Proxy Advisors Have a 

Significant Impact on Voting Outcomes 

As the factors discussed above have driven investment 

managers to rely more heavily on proxy advisors, most large 

institutional investors have separated the persons making 

investment decisions from the process for voting proxies - either 

by delegating voting decisions to a separate internal group or by 

outsourcing some or all of the voting process to third-party proxy 

advisors.36 Most industry observers concur that proxy advisors, 

particularly ISS, now have a significant influence on vote 

outcomes. This sentiment was summed up by Delaware Court of 

Chancery Vice Chancellor Leo E. Strine Jr., who stated, 

"[f]ollowing ISS constitutes a form of insurance against regulatory 

criticism, and results in ISS having a large sway in the affairs of 

American corporations.,,37 In fact, Strine has written that "[t]he 

influence of ISS and its competitors over institutional investor 

voting behavior is so considerable that traditionalists will be 

concerned that any initiative to increase stockholder power will 

simply shift more clout to firms of this kind .... ,,38 

©2011 Center On Executive Compensation 19 
75 


81762.038

A Call for Change in the Proxy Advisory Industry Status Quo 

While there is little doubt that the proxy advisors influence 

voting, a lively academic debate has emerged over exactly how 

many votes they can sway. Susan E. Wolf, former Vice President 

and Corporate Secretary at Schering-Plough and the former 

Chairman of the Society of Corporate Secretaries and Governance 

Professionals, has said that some of the organization's corporate 

members think that ISS alone controls one-third or more of their 

shareholder votes39 According to recent statistics from Innisfree 

M&A, a proxy solicitation firm, ISS clients typically control 20 to 

30 percent of a midcap to largecap company's outstanding shares, 

while Glass Lewis clients typically control 5 to 10 percent.40 

Academic Studies Attempt to Quantify ISS Influence. 

Several academic studies have been conducted attempting to 

quantify how much influence proxy advisors have on the outcome 

of issues brought to shareholder votes. In 2002, a study published 

in the journal, Financial Management, found that ISS 

recommendations had a substantial impact on voting results, with 

unfavorable ISS recommendations on management proposals 

linked to 13.6 percent to 20.6 percent fewer affirmative votes for 

management proposals depending on the specific proposal type.41 

Another academic study published by the European Corporate 

Governance Institute found that ISS recommendations were 

significantly related to the passage of management proposals 42 

More recently, a study by three business school professors and 

a staff member of the SEC examined ISS voting recommendations 

in 198 contested elections from 1992 through 2005, where 

dissidents were seeking board scats.43 The study found that ISS 

vote recommendations in such situations "are good statistical 

predictors of contest outcomes, even after controlling for a variety 

of contest, firm, dissident, and management characteristics.,,44 In 

addition, the study found that ISS proxy recommendations seemed 

to playa "certification role" in influencing investors to revise their 

assessments of the quality of dissident board nominees.45 Another 

study of the influence of four major proxy advisory firms in 

director elections concluded that, after controlling for the 

underlying factors that influenced advisory firm recommendations, 

"advisor recommendations in general, and ISS in particular, appear 

to be less influential than commonly perceived," with ISS voting 

recommendations directly swaying 6 to 9 percent of institutional 

votes.46 Yet, even with this lower estimate, ISS's influence over 

large companies is frequently greater than the company's largest 

shareholder. 

©2011 Center On Executive Compensation 20 
76 


81762.039

A Call for Change in the Proxy Advisory Industry Status Quo 

While the academic debate over exactly what percentage of 

votcs each proxy advisor can influence on any given issue will no 

doubt continue, the fact that proxy advisory firms can influcnce or 

control a significant block of votes on corporate proxy issues is 

undeniable. Moreover, the perceived influence of proxy advisors 

by board membcrs is just as important as the advisors' actual 

impact. As two White & Case lawyers who studied the industry 

recently concluded: 

[L]ittle doubt exists that proxy advisors, at a minimum, 

have had a meaningful impact on some shareholder votes, 

particularly those in connection with closely fought 

proposals. Moreover, if most directors believe that ISS has 

power - as their actions indicate - boards may do what they 

believe ISS wants them to in order to keep their seats, 

whether or not their belief is justified. Similarly, if most 

institutional investors follow the same proxy advice closely, 

the impact of that advice on U.S. corporate governance 

could be very significant. For these reasons, it is incumbent 

on proxy advisors to operate with fiJlltransparency, ideally 

pursuant to self-imposed industry-wide standards that result 

in clear disclosure to institutional and retail investors alike 

in connection with voting recommendations. 47 

In the current environment where many proxy issues are 

increasingly being decided on very close votes, this fact reinforces 

the need to ensure the integrity of the process by which those 

advisors are making vote recommendations. Based on the conduct 

of the industry so far, self-regulation will not accomplish this goal. 

F. Regulatory Changes Will Increase Further the 

Number and Influence of Proxy Votes 

Recent significant changes in financial regulations promise to 

further increase the volume and impact of proxy votes and the 

influence of the proxy advisory firm industry. These changes 

include: 

the proliferation of majority voting; 

mandatory say on pay votes; 

elimination of broker discretionary voting in uncontested 

director elections and on compensation matters; and 

new SEC rules governing proxy access in the nomination of 

directors. 

While the impact of anyone of these changes on the power and 

influence of proxy advisory firms might not be overwhelming, the 

cumulative impact of all of them - and the way that these measures 

interact - is likely to dramatically increase the power of the proxy 

advisors and cause significant unintended consequences. This is 

©2011 Center On Executive Compensation 21 
77 


81762.040

A Call for Change in the Proxy Advisory Industry Status Quo 

particularly significant, because there is no effective supervision of 

the proxy advisors beyond the minimal regulatory oversight 

associated with being an investment adviser for those firms that 

have voluntarily chosen to register as investment advisers. 

The potential impact and significance of each of these key 

regulatory changes on the proxy advisory industry is discussed 

below. 

Majority Voting. A fundamental right of shareholders under 

state corporate law is the right to elect corporate directors. Until 

several years ago, virtually all U.S. companies elected their 

directors using plurality voting. Under a plurality voting system, 

the director nominees who receive the most votes are elected up to 

the maximum number of directors to be chosen in the election 

without regard to votes "withheld," voted against or not cast. In an 

uncontested election, however, this system effectively means that a 

single vote cast "for" a nominee would be sufficient to win that 

nominee a board seat. 

Beginning in 2004, a number of shareholder groups and union 

pension funds mounted campaigns to urge companies to embody a 

majority voting standard in their bylaws, corporate charters or 

governance documents. Under majority voting, a director typically 

needs to obtain support from a majority of the shares cast in order 

to be legally elected.48 The United Brotherhood of Carpenters & 

Joiners of America (Carpenters Union) was among the early 

supporters of majority voting, submitting 12 shareholder proposals 

on the issue in 2004. In 2005, encouraged by the voting support 

for its proposals the previous year, the Carpenters Union and other 

building trade union funds submitted 89 proposals on majority 

voting of which 16 garnered majority support from shareholders:9 

Also in 2005, the Council ofInstitutional Investors launched a 

letter-writing campaign to 1,500 ofthe largest U.S. corporations 

requestin~ them to adopt majority voting in uncontested director 

elections. 0 In 2006, the Model Business Corporation Act 

(MI3CA) and the Delaware General Corporation Law were 

amended to facilitate the adoption of majority voting by company 

boards or by shareholders. 

Major public and union pension funds, such as the California 

Public Employees Retirement System (CalPERS) and American 

Federation of State, County and Municipal Employees (AFSCME), 

joined the majority voting campaign by submitting nonbinding 

shareholder proposals calling for the adoption of majority voting at 

dozens of companies, and these proposals have continued to attract 

strong support. In 2010, for instance, 19 proposals were submitted 

seeking the adoption of majority voting received majority 

shareholder supportY 

©2011 Center On Executive Compensation 22 
78 


81762.041

A Call for Change in the Proxy Advisory Industry Status Quo 

Overall, the changes in Delaware law and the MBCA, as well 

as the shareholder campaigns in favor of adoption of a majority 

voting standard, have been quite effective, at least among the 

largest U.S. corporations. More than two-thirds of the companies 

in the S&P 500 Index have now adopted some form of majority 

voting - making it the de facto standard among large 

corporations. 52 

The impact of the widespread adoption of majority voting is to 

greatly increase the leverage that investors (and hence proxy 

advisory firms) have over corporate directors. Because most 

shareholder proposals are advisory in nature, some companies have 

chosen not to implement specific proposals with which they 

disagree, even when those proposals have been supported by a 

majority of shareholders.53 A number of proxy advisory firms and 

investors have reacted to such company decisions not to implement 

majority shareholder-supported governance measures by 

"withholding" votes from incumbent directors up for election at 

these companies. Under plurality voting elections, such "no vote" 

campaigns or recommendations were essentially symbolic. Under 

new majority voting regimes, however, they have the potential to 

unseat directors - or at a minimum put boards in the awkward 

position of explaining why they should override the wishes of a 

majority of their shareholders. 

Shareholder Sayan Pay and Related Compensation 

Votes. In recent years, a relatively small number of U.S. 

companies, under pressure from shareholder campaigns, have 

voluntarily implemented nonbinding shareholder votes on 

executive compensation (commonly referred to as say on pay 

votes). Reflecting the platform of the Obama Administration, 

Congress embraced the idea, first by making annual say on pay 

votes mandatory for all U.S. companies that were recipients of 

taxpayer funds under the Troubled Asset Relief Program (TARP), 

which was signed into law in October 2008.54 It expanded say on 

pay to all U.S. public companies in the Dodd-Frank Wall Street 

Reform and Consumer Protection Act, which was enacted on July 

21,2010." 

Although nearly 200 shareholder proposals requesting that 

individual companies adopt an advisory say on pay vote had been 

filed since between January 2006 and October 2010, collectively, 

these resolutions received majority support from shareholders less 

than 30 percent of the time56 What activists had difficulty 

achieving through company votes, they achieved through 

legislation. Section 951 of the Dodd-Frank Act requires 

corporations to hold a nonbinding shareholder say on pay vote at 

least once every three years to "approve" executive compensation 

©2011 Center On Executive Compensation 23 
79 


81762.042

A Call for Change in the Proxy Advisory Industry Status Quo 

as disclosed in the proxy statement In addition, the Act requires a 

separate shareholder votc at least once every six years to determine 

whethcr such say on pay votes should be held annually, biennially 

or triennially. The ncw requirements apply to shareholder 

meetings which occur after January 21, 2011, meaning virtually all 

companies will have to hold a "say on pay" and a "frequency" vote 

during the 2011 proxy season. 

The Dodd-Frank Act includes several other provisions that will 

enhance the power of proxy advisors. These include a requirement 

that executive compensation payments related to a sale, merger, 

acquisition or other disposition of assets requiring shareholder 

approval bc disclosed in a more detailed manner and, in certain 

cases, subject to a nonbinding shareholder vote. The law also 

requires all institutional investors subject to reporting under the 

Securities and Exchange Act of 1934 to report annually on how 

they voted on all say on pay and golden parachute votes. 

The overall impact of these provisions will be to put many 

more compensation-related votes on corporate ballot~ and to make 

the voting records of many more institutions on these issues a 

matter of public record. Because many institutional investors will 

not have the time or resources to evaluate the executive 

compensation practices for their portfolio holdings of up to 10,000 

publicly held companies, they will need to rely on outside services, 

especially proxy advisors, for analysis and voting 

recommendations on compensation matters. 

A recent survey of251 companies by Towers Watson, a global 

professional services firm, found that 59 percent of respondents 

believed that proxy advisors already have significant influencc on 

executive pay decision-making processes at U.S. companies57 

Some shareholder activists agree and predict that the advisory firm 

role will be strengthened. Edward Durkin, director of corporate 

affairs at the Carpenters Union, has noted it will be impossible for 

most institutional investors to vote on hundreds or thousands of 

compensation plans unless they rely on the advice of proxy 

advisory firms. "If you have an annual say on pay vote and you 

exercise your voting responsibility as we do ... it'd be 

overwhelming," said Durkin, whose union owns stakes in 3,500 • 58 compames. 

Proxy advisory firms clearly anticipate that say on pay will 

expand their influence. Patrick McGurn, Special Counsel to ISS, 

noted this point in 2010 while admonishing corporations to provide 

executive summaries for the Compensation Discussion and 

Analysis (CD&A) sections of their proxy statements. As filings 

became more voluminous, investors would not search through long 

©2011 Center On Executive Compensation 24 
80 


81762.043

A Call for Change in the Proxy Advisory Industry Status Quo 

CD&As, McGurn said, so a failure to provide an executive 

summary means "you are giving more power to proxy advisors;' 

who would read through the whole document. 59 Earlier, Peter 

Clapman, the former Senior Vice President and Chief Counsel for 

TIAA-CREF, expressed a similar sentiment, but questioned the 

wisdom ofthis approach: 

If applied to a universe of IO,OOO-plus public companies in 

the U.S. (in contrast to far fewer companies in the U.K.), 

most shareholders simply will not devote the necessary staff 

resources to vote intelligently as individual shareholders 

and will outsource the voting decision. The inevitable 

consequence would be to transfer considerable discretionary power over individual company compensation practices to the proxy advisory finns. I question that such an 

approach will serve the long-tenn best interests of shareholders.GO 

The overall effect of say on pay will be to increase the 

influence of proxy advisory firms as investors grapple with more 

than 16,000 additional proxy votes in 2011, many of which will 

require an understanding of each company's pay philosophy and 

arrangements. 

Elimination of Broker Discretionary Voting in Uncontested 

Elections and on Key Compensation Issues. In the current 

U.S. proxy system, broker-dealers have a significant influence on 

proxy voting outcomes in their role as intermediaries between 

relail investors and corporate issuers. Public company 

shareholders can hold shares in one of two ways: directly, as 

record holders, or indirectly, in so-called "street name" accounts 

through their brokers. Under SEC and New York Stock Exchange 

(NYSE) rules, when investor shares are held with brokers in "street 

name," the broker is required to deliver proxy materials to the 

shareholder with a request for specific voting instructions on any 

matters 10 be voted on at the annual meeting. 

Under NYSE Rule 452, iflhe broker does not receive voting 

instructions hy the lOth day preceding a company's annual 

meeting, the broker is allowed to exercise discretionary voting 

authority 10 vote on all matters deemed "routine" by Ihe NYSE. 

Brokers arc nol allowed to vole on matters deemed "non-routine" 

by the NYSE, such as shareholder proposals, without a specific 

inslruction from the shareholder. 

Until recently, voles 10 elect directors in uncontested elections 

were considered "rouline" matters under NYSE Rule 452. On July 

1,2009, however, the SEC approved an amendment to thai rule to 

eliminate broker discretionary voting in uncontested eleclions.61 

©2011 Center On Executive Compensation 25 
81 


81762.044

A Call for Change in the Proxy Advisory Industry Status Quo 

The amendment applied to director elections on or after January I, 

2010, and affects all public companies, not just those listed on the 

NYSE, The change was made by the NYSE following the 

recommendation of its Proxy Working Group. It was based 

heavily on arguments that voting in director elections is one of the 

most important ways that shareholders can influence corporate 

governance and that this right should be limited to those who hold 

an economic interest in the company. 

The rule change is potentially quite significant because broker 

discretionary votes have typically been cast in favor of 

management and can comprise up to 20 percent of proxy votes at 

some companies. With a dramatic increase in elections where 

directors receive significant numbers of "withheld" votes in recent 

years, the elimination of broker discretionary voting could result in 

more directors failing to achicve majority support from 

shareholders 62 

The NYSE's amendment to Rule 452 has also influenced 

legislation addressing the financial crisis. The 2010 Dodd-Frank 

Act directs the SEC to issue new regulations prohibiting broker 

discretionary voting of client securities held in street name on 

executive compensation issues, including say on pay and golden 

parachute votes as well as "any other significant matter" as 

determined by the Commission.6l The legislation effectively 

extends the rationale of prohibiting uninstructed broker votes in 

director elections to compensation issues - with the inference that 

say on pay votes are important ways shareholders can influence 

executive compensation. However, many believe that the effect 

will be to disenfranchise many retail shareholders, thus further 

strengthening the dominance of institutional investors in the proxy 

voting process. 

In sum, the elimination of broker discretionary voting in 

director elections and on important compensation matters will 

erode the impact of retail investors in proxy voting and enhance 

the influence of institutional investors. It will also further expand 

the power ofthe proxy advisory services over governance matters. 

Proxy Access for the Nomination of Directors. On August 

25,20 I 0, the SEC voted by a 3 to 2 margin to enact a rule granting 

"proxy access" to certain shareholders for the purpose of 

nominating directors on a company's proxy ballot64 The rule will 

allow shareholders meeting certain ownership requirements (three 

percent of a company's shares held continuously for a minimum of 

three years) to nominate directors comprising up to 25 percent of 

the board on the company's proxy card. The rule applies to all 

U.S. corporations, but it exempts small companies from 

©2011 Center On Executive Compensation 26 
82 


81762.045

A Call for Change in the Proxy Advisory Industry Status Quo 

compliance with the rule for a period of three years.65 The SEC 

also amended Rule 14a-8 to allow shareholder proposals seeking 

bylaw amendments relating to proxy access.66 The rule allows 

shareholders to use such proposals to alter proxy access restrictions 

at specific companies to make them less stringent but not more 

stringent - than the requirements set in the SEC's rule. 

The final proxy access rule was adopted after hundreds of 

public comments were filed on the SEC's proposed rule, which 

was released in May 2009. A vote on a final rule was delayed until 

after final Congressional passage of financial reform legislation, 

with many observers speculating that the delay was due to 

concerns by the SEC about possible court challenges to its 

statutory authority to enact proxy access. The Dodd-Frank Act 

sought to address such concerns by explicitly authorizing the SEC 

to adopt rules governing proxy access. However, the validity of 

the rule is being challenged in federal court/7 and the SEC has 

suspended its implementation pending the court's ruling. If the 

rule is ultimately upheld, the long-term impact will be to increase 

the number of contested elections On which institutional investors 

need to vote. As Judy Schub, former Managing Director of the 

Committee on Investment of Employee Benefit Assets (CIEBA), 

an association of more than 100 of the largest U.S. private sector 

pension plans, noted in a comment letter to the SEC on proxy 

access: 

CIEBA members are also concerned that the proposal, as 

drafted, will enhance the authority of the proxy advisory 

services. Currently, only three organizations control the 

business, with one of the three enjoying the dominant 

market position. There is little oversight or regulation of 

these proxy advisory services by any public entity nor is 

there any meaningful disclosure about the significant role 

they play in proxy voting decisions. They exercise 

significant power over corporate governance since the va.;;t 

majority of institutional investors use their guidance on 

proxy voting. These new proxy access standards will give 

them even greater power over the election of boards of 

directors. 68 

In sum, the proxy advisory industry has greatly expanded its 

power and influence over corporate governance in the U.S. in 

recent decades. This expansion is the result of a combination of 

underlying economic factors - which have driven institutions to 

look for third-party help in dealing with ever increasing workloads 

related to proxy voting - coupled with regulatory developments 

that have both directly and indirectly encouraged the use of proxy 

advisors. 

©2011 Center On Executive Compensation 27 
83 


81762.046

A Call for Change in the Proxy Advisory Industry Status Quo 

IV. The Proxy Advisory Firms and 

Their Services 

Proxy advisors playa significant and growing role in 

influencing shareholder votes in thc U.S. and global proxy voting 

system. Thc industry in the U.S. is highly concentrated, with a 

handful of firms controlling virtually the entire market for proxy 

research and advice and one entity Institutional Shareholder 

Services - holding a dominant market position. In theory, proxy 

advisors are subject to significant regulatory standards that govcrn 

their conduct. In practice, however, there have been few, if any, 

constraints on proxy advisors, and there is significant concern by 

companies, investors and others that conflicts of interests influence 

their recommendations. This section will briefly describe the 

history and services provided by each of the proxy advisory firms, 

which puts into context the conflicts and operations concerns 

discussed later in this paper. 

A. Institutional Shareholder Services 

Institutional Shareholder Services (ISS), the dominant firm in 

the proxy advisory business, is currently a division of MSCI Inc., a 

leading provider of investment decision support tools and indexes 

to investors worldwide. ISS has undergone two changes in 

ownersbip in recent years: in January 2007, it was purchased by 

RiskMetrics Group Inc. for $542.6 million in casb and stock.69 

RiskMetrics is a leading provider of risk assessment and wealth 

management products that was spun off from J.P Morgan Chase & 

Co. in 1998. Then, after RiskMetrics went public in January 2008, 

RiskMetrics was acquired by MSCI on June I, 2010, in a cash and 

stock transaction valued at $1,572.4 million7o 

ISS is a Delaware corporation that is also a registered 

investment adviser regulated by the SEC. ISS is headquartered in 

Rockville, Maryland, and maintains offices in New York City, 

Chicago, Illinois, Norman, Oklahoma, London and Makati City, 

Philippines. It also has affiliates in Europe, Canada, Japan and 

Australia and has between 500 and 1,000 employees worldwide. 71 

History and Ownership: ISS was founded in 1985 by Robert 

A.G. Monks, a former administrator of the Office of Pension and 

Welfare Benefits Programs at the U.S. Department of Labor under 

President Reagan, who also appointed him as one of the founding 

trustees of the Federal Employees' Retirement System. Monks 

served as President ofiSS from 1985 to 1990. 

©2011 Center On Executive Compensation 28 
84 


81762.047

A Call for Change in the Proxy Advisory Industry Status Quo 

ISS has a long history of acting as a consolidator within the 

proxy industry as well as being bought and sold itself at ever 

increasing valuations. A list of the major acquisitions by, and 

purchases of, ISS is shown in Table 1 below. As 0[2010, it had 

made at least eight acquisitions of other firms in the proxy 

advisory, governance and corporate responsibility sectors since 

1985. 

TABLE 1: Timeline of Institutional Shareholder Services 

(ISS): The Proxy Industry Consolidator 

1985 -ISS founded Monks 

June 1995 ISS is acquired by the CDA unit of Thomson 

Financial Services, a unit of The Thomson Corp. 

1997 ISS acquires Proxy Voter Services, a proxy advisor to 

union funds 

August 2001 - Proxy Monitor purchases ISS from Thomson 

Financial, with major financial backing from Warburg Pincus, 

Hermes Investment Management Ltd. and others for a reported 

sale price of $45 million. The merged company retains the ISS 

name and installs Robert C.S. Monks, son of Robert A.G. Monks, 

as Chairman 

May 2005 ISS completes acquisition of the corporate 

governance unit of Brussels-based Deminor International for $1.0 

million 

June 2005 - ISS completes acquisition of Proxy Australia Ply 

Ltd., Australia's leading governance research firm for $0.7 million 

August 2005 -ISS completes acquisition of IRRC, a leading U.S. 

proxy research firm for $14.3 million 

January 2007 - RiskMetrics completes acquisition of ISS for 

$542.6 million in cash and stock 

July 2007 RiskMetrics announces definitive agreement to 

acquire the Center for Financial Research and Analysis (CFRA), a 

leading financial forensic analysis firm, for $61.4 million 

January 2008 - RiskMetrics prices IPa 

February 2009 RiskMetrics announces acquisition of Innovest 

Strategic Value Advisers, an environmental investing research firm 

for $14.3 million in cash 

November 2009 RiskMetrics completes acquisition of KLD 

Research and Analytics, a leading ES&G research firm for $9.9 

million in cash 

June 2010 - MSCI completes acquisition of RiskMetrics Group for 

.6 billion 

©2011 Center On Executive Compensation 29 
85 


81762.048

A Call for Change in the Proxy Advisory Industry Status Quo 

ISS was sold by its founders in June 1995 to a unit of Thomson 

Financial Services (currently Thomson Reuters), a Canadian 

publishing and information services conglomerate. Six years later, 

in August 2001, Thomson sold ISS for a reported $45 million to a 

group of financial investors, including the U.S. private equity firm 

Warburg Pincus, Hermes Investment Management Ltd. (a unit of 

the Hermes Group, a wholly-owned subsidiary of the BT Pension 

Scheme the pension fund for the U.K.'s largest 

telecommunications firm). Together, Warburg Pincus and Hermes 

owned approximately 57 percent of the equity in ISS.72 The sale 

included a reverse merger into a smaller proxy advisory firm called 

Proxy Monitor, with the merged firm retaining the ISS name. 

Interestingly, Robert C.S. Monks, the son ofISS's founder, was 

named chairman of the merged company, a post he held until the 

company's sale to RiskMetrics in 2007. 

Several years after the merger with Proxy Monitor, in 2005, 

ISS embarked on an acquisition strategy, purchasing in rapid 

succession three proxy research and governance businesses - the 

commercial business assets of the Investor Responsibility Research 

Center (IRRC), the governance business of Belgium-based 

Deminor International and Proxy Australia Ply Ltd. The three 

purchases augmented ISS's already dominant worldwide market 

position at that time. After being purchased by the RiskMetrics 

Group, Inc. in 2007, several additional firms were integrated into 

ISS - notably CFRA, Innovest Strategic Value Advisers and KLD 

Research & Analytics. CFRA was a leading forensic accounting 

analysis firm and Innovest and KLD each had a long history of 

providing environmental, social and governance research to 

institutional investors. 

A comment by MSCI CEO Henry Fernandez at the time of the 

closing ofMSCl's purchase of RiskMetrics has led to speculation 

that the ISS segment of RiskMetrics could be sold again. 

Fernandez called the ISS part of RiskMetrics "non-core" in an 

investor conference call, but said the finn planned to retain it 

because of its cash generation. 73 Ethan Berman, the CEO of ISS 

since 1998, later reinforced the possibility of an ISS sale, saying 

that selling ISS "is not the intent but is a possibility.,,74 As of 

August 20 I 0, persistent market rumors were circulating that ISS 

was again being shopped, with private equity firms showing 

interest. 

Current Services and Business. According to the 2009 Fonn 

10-K filing for RiskMetrics Group, ISS provided services to 

approximately 2,970 clients as of year-end 2009 through a network 

of20 offices in 12 countries75 ISS divides its services into two 

general categories: Governance Services and Financial Research 

©2011 Center On Executive Compensation 30 
86 


81762.049

A Call for Change in the Proxy Advisory Industry Status Quo 

and Analysis Services. Within the Governance Services segment, 

the company further categorizes its services into three business 

areas: Proxy Research and Voting, Global Proxy Distribution 

Services and Securities Class Action Services. 

Regarding proxy research and voting, the company notes that it 

is the largest firm in the industry and says that it "offers a fullyintegrated, end-to-end proxy voting service, including policy 

creation, comprehensive research, vote recommendations, reliable 

vote execution and reporting and analytical tools.,,76 It says it 

issued proxy research and recommendations for more than 37,000 

shareholder meetings in 108 countries and voted, on behalf of its 

clients, more than 7.6 million ballots representing over 1.3 trillion 

shares in 2009. 

The Global Proxy Distribution Services business offers a 

global proxy distribution solution to custodian banks for non-U.S. 

securities through a single platform. The Securities Class Action 

Services business delivers class action monitoring and claims filing 

services to institutional investors who have potential recovery 

rights in class action lawsuits. 

In its Financial Research and Analysis segment, ISS has four 

principal business lines: CFRA forensic accounting research, 

Environmental, Social & Governance Services (ES&G), M&A 

Edge and Compensation Advisory Services. The CFRA forensic 

accounting research provides risk analysis reports on earnings and 

cash flow quality, legal and regulatory risk and general business 

health for more than 10,000 companies worldwide. The ES&G 

Services include screening and modeling tools to allow 

institutional investors to apply social guidelines or restrictions to 

portfolios as well as company-specific reports, profiles and 

analytics. The M&A Edge service provides in-depth analysis on 

proposed merger and acquisition transactions and proxy contests. 

The Compensation Advisory Services provide products and 

services designed to allow compensation professionals and 

corporate board members to model, optimize and benchmark 

executive compensation plans. This segment offers both corporate 

advisory services that include access to compensation analysts or a 

web-based compensation modeling tool that measures the cost of 

equity incentive plans using ISS's proprietary binomial option 

pricing model. This sale of consulting services to corporations at 

the same time it is advising investors how to vote on management 

and shareholder proposals on the same issues has been a highly 

criticized and controversial aspect ofISS's business model. 

©2011 Center On Executive Compensation 31 
87 


81762.050

A Call for Change in the Proxy Advisory Industry Status Quo 

Significant Share of Goodwill Written Off in Recent Years. 

ISS's revenues and profitability for 2009 are disclosed in 

RiskMetrics' 2009 Form 10-K filing, which shows total 2009 ISS 

revenues of$144.7 million, up 2.0 percent from $141.8 million in 

2008.77 On a product basis, Governance Services (mainly proxy 

research and voting) accounted for $92.4 million in revenues, 

while Financial Research and Analysis accounted for $52.3 

million. ISS segment income from operations in 2009 was $10.9 

million, up from a loss of $148.7 million in 2008, when results 

were negatively impacted by a $154.2 million non-cash writedown to ISS goodwill "primarily as a result of the negative equity 

market conditions which caused a material decline in industry 

market multiples in the second half of2008" and a $5.9 million 

write-down related to an ISS product trademark. 78 

Consulting Services May Support Advisory Operations. 

ISS has also disclosed on its website that approximately 17 percent 

of its total revenues are generated from its Ies subsidiary, which 

provides consulting services to corporations.79 This consulting 

revenue is highly significant because it is widely believed to be 

highly profitable to ISS (because much of it results from charging 

corporations for use of elements of the ISS compensation model). 

In fact, some observers believe that without this highly profitable 

revenue source, ISS's operations would be unprofitable or, at best, 

only marginally profitable. This may account for the firm's 

reluctance to spin-off or otherwise separate this business - in spite 

of the tremendous amount of criticism it has engendered for 

creating conflicts of interest, as discussed in depth later in this 

paper. 

Offshoring. In recent years, ISS has made a major push to 

reduce its cost structure by locating much of its data collection and 

research activities outside the United States, particularly to the 

Philippines. The 2009 RiskMetrics Form 10-K acknowledges the 

importance of this, stating: 

ISS' clients outsource proxy voting and vote reporting to ISS. 

We have had success in meeting client requirements while 

also increasing our transactional volume through increased 

automation and by leveraging OUf operations center in 

Manila, Philippines. This operations center reduces the 

operational cost per transaction and has been a key 

component of our success. 80 

In March 2010, ISS introduced a new scoring system designed 

to measure corporate governance practices known as Governance 

Risk Indicators (or GRId). The new indicator is based on an 

evaluation of a company's compliance with what ISS has 

determined are "best practices" in four key governance areas: 

©2011 Center On Executive Compensation 32 
88 


81762.051

A Call for Change in the Proxy Advisory Industry Status Quo 

audit, board structure, shareholder rights and compensation, 

Scores for U,S, companies are based on answers to 63 questions in 

these areas, The GRid corporate governance indicator replaced a 

former ISS indicator known as the Corporate Governance Quotient 

(CGQ), which ISS had widely promoted for years as a useful 

indicator for assessing corporate governance. CGQ scores were 

discredited by some academic studies, however, which found that 

they did not predict future financial performance or governancerelated outcomes or provide useful information to shareholders81 

B. Glass, Lewis & Co. 

Glass, Lewis & Co. was founded in January 2003 and is the 

second largest firm in the proxy advisory industry. It is currently 

an indirect wholly-owned subsidiary of The Ontario Teachers' 

Pension Plan Board (OTPP), One of the largest pension systems in 

Canada, which creates the potential for considerable conflicts as 

well. The finn has more than 100 employees and is headquartered 

in San Francisco, California, with offices in New York, Sydney, 

Paris and Tokyo. Glass Lewis is organized as a limited liability 

corporation, incorporated in Delaware, and is not registered as an 

investment adviser with the SEC. 82 

History and Ownership. Gregory P. Taxin, Lawrence M. 

Howell, and Kevin J. Cameron, co-founded Glass, Lewis & Co. in 

2003 83 Taxin had been an investment banker at Bank of America 

Securities and Epoch Partners, as well as a Vice President in the 

investment banking division at Goldman, Sachs & Co. Howell 

also had a background as an investment banker at Goldman Sachs 

and Morgan Stanley & Co. and, since 1996, had been the 

managing partner at Howell Capital, an investment consulting and 

advisory finn. Cameron was a lawyer who had served as the 

general counsel of Moxi Digital, a technology venture, and 

Northpoint Communications, a telecommunications firm. Taxin 

became Glass Lewis' CEO, Howell served as chairman and 

Cameron became president. 

According to Rustic Canyon Partners, a venture capital firm 

that was an early investor in the firm, Glass Lewis was initially 

capitalized by its founders and a group of research analysts, 

accountants, publishers and bankers.8 

The firm grew relatively quickly after its initial launch due in 

part to the fact that while it did not initially have an electronic 

voting platform to provide comprehensive voting services, it 

negotiated an arrangement with IRRC in late 2003 to make its 

proxy analyses and recommendations available to IRRC's voting 

©2011 Center On Executive Compensation 33 
89 


81762.052

A Call for Change in the Proxy Advisory Industry Status Quo 

clients. The deal provided Glass Lewis with a fast and efficient 

way to reach IRRCs hundreds of voting clients. (IRRC was 

interested because its research reports did not offer voting 

recommendations which were increasingly demanded by many 

institutional investors.) By the time IRRC was purchased by ISS 

in 2005, many of its clients had already been exposed to Glass 

Lewis' research and kept their services with that firm (which had 

by then developed its own voting platform). 

The firm also diversified its offerings to include forensic 

accounting reports and alerts designed to aid investors in spotting 

companies with suspicious accounting practices - a timely service 

in the wake of accounting scandals at companies such as Enron 

and WorldCom. It also developed, in conjunction with several 

business professors, a governance-enhanced S&P 500 Index, 

dubbed the board accountability index, which was designed to 

weight companies in the index based on their governance 

characteristics. 

In September 2005, Glass Lewis raised approximately $4 

million through the sale of preferred stock in the firm to accredited 

investors. An SEC filing for the offering at that time listed - in 

addition to the founders and Rustic Canyon three additional 

owners: Lynn Turner, Shamrock Estate Holdings LLC (Burbank, 

Cal.) and Ojibawa Investment Partners (Chicago, 111.)85 Turner 

was a former chief accountant at the SEC who was recruited in 

2003 to be Glass Lewis' managing director of research. By 2006, 

Glass Lewis had about 200 clients and was rapidly expanding its 

research coverage to overseas markets. 

In August 2006, Glass Lewis announced that Xinhua Finance 

Ltd., a leading financial information and media provider in China, 

had purchased a 19.9 percent stake in the company. Then, in 

December, it announced that Xinhua would exercise an option to 

purchase the remaining equity in the firm, with the deal expected 

to close in early 2007. The total purchase price for the Glass 

Lewis, paid partly in cash, but mostly in Xinhua Finance stock, 

was approximately $45 million. Xinhua Finance is headquartered 

in Shanghai, China, has its stock listed on the Mothers Board of the 

Tokyo Stock Exchange and is incorporated as a holding company 

in the Cayman Islands.86 In announcing the transaction, Glass 

Lewis said it planned to expand its coverage to Chinese and other 

emerging market companies, but would continue to operate as a 

separate comparl with its existing management, client service and 

research learns. 

©2011 Center On Executive Compensation 34 
90 


81762.053

A Call for Change in the Proxy Advisory Industry Status Quo 

Within months after closing its deal with Xinhua Finance 

though, therc were ominous signs oftroublc at the parent company. 

In March 2007, Xinhua Media, the unit of Xinhua Finance of 

which Glass Lewis was part, raised $300 million through an initial 

public stock offering in the U.S. Media reports soon emerged, 

however, that the IPO prospectus had failed to disclose that Shclly 

Singhal, thc CFO of Xinhua Finance and Xinhua Media, had 

perfonned investment banking services for two companies that had 

been exposed as frauds and that he was being sued in California 

civil court for racketeering. 

In April, it was announced that CEO Greg Taxin would leavc 

Glass Lewis for a new position focused on business development 

a( Xinhua Financc Ltd. and would be replaced by Katherine Rabin. 

Then, in May, two of Glass Lewis' prominent senior executives 

quit. First, Jonathan Weil, a managing director who was a fonner 

Wall Street Journal reporter, announced he was leaving, stating 

publicly in his resignation letter that he was "uncomfortable and 

deeply disturbed by the conduct, background and activities of our 

new parent company Xinhua Finance Ltd., its senior management, 

and its directors. To protect my reputation, I no longer can bc 

associated with Glass Lewis or Xinhua Finance."s8 The following 

week, on May 21, 2007, Lynn Turner, the finn's managing director 

for research, also announced he would resign from the firm, citing 

"recent changes in ownership,',89 

The disclosures left Glass, Lewis & Co., which had built its 

reputation largely on its ability to identify corporate accounting 

problems, scrambling to retain its clients, many of whom were also 

reported to be uneasy over the prospect of purchasing proxy and 

forensic accounting research from a finn now owned by an 

infonnation and media conglomerate with close ties to the Chinese 

government. By October 2007, it was announced that Xinhua 

Finance would sell Glass Lewis (0 the Ontario Teachers' Pension 

Plan for $46 million. OTPP was a client of Glass Lewis and had 

helped to create a Canadian investor group dedicated to improving 

corporate governance.90 

Current Services and Business. According to Glass 

Lewis's website, the finn provides research and analysis on more 

than 16,000 companies around the world. The company lists six 

services it provides: Risk Alerts, Risk Monitor, Proxy Research 

and Voting Solutions, Trend Reports, Share Recall Service and 

Class Action Settlement Solutions. The finn is not registered as an 

invcstment adviser and hence is not directly regulated by the SEC. 

©2011 Center On Executive Compensation 35 
91 


81762.054

A Call for Change in the Proxy Advisory Industry Status Quo 

Risk Alerts and Risk Monitor are web-based applications that 

enable invcstors to monitor public companies for signs of unusual 

risk or developments that could hann shareholders and provide 

rankings ofa company's relative risk based on more than 30 data 

patterns that Glass Lewis has identified as predictive of risk to 

shareholder value. The serviccs provide a review of earnings 

quality and presents relative risk Scores for more than 4,200 North 

American securities. 

Glass Lewis says its proxy research scrvice, called Proxy 

Paper, covers more than 16,000 public companies in 70 countries. 

Thc company says Proxy Paper is available "as a standalone 

service or as part of a turnkey solution that encompasses all aspects 

of the proxy voting process - including reconciliation, vote 

execution, record keeping and reporting, Fonn NPX and Web 

hosting.,,91 The company says its voting platfonn and system, 

called Viewpoint, is designed to provide accurate, transparent and 

auditable voting. 

Glass Lewis's Trend Reports are comprehensive studies on 

accounting issues and regulatory developments that 

disproportionately affect certain industries of companies. Its Share 

Recall Service is designed to allow institutions that lend shares to 

maximize these programs by selectively recalling shares on loan, 

for certain important proxies, based on a proprietary algorithm that 

analyzes and scores various factors such as accounting 

restatements, excessive executive compensation and prior year 

voting results. Its Class Action Settlement Solutions handles all 

aspects of class action claims, including identifying eligible claims 

and amounts, filing claims, following up on rejections and auditing 

amounts recovered against claim amounts. 

c. Proxy Governance, Inc. 

Proxy Governance Inc. (PGI) was founded in June 2004 by 

Steven Wallman, who served as an SEC Commissioner from 1994 

to 1997 under President Clinton. Until December 2010, the firm 

was a wholly-owned subsidiary of FOLlOfn, Inc., a financial 

services and technology finn based in McLean, Virginia, where 

Wallman serves as CEO. Proxy Governance was incorporated in 

Virginia and the finn was registered as an investment adviser with 

the SEC. On December 20,2010, Glass Lewis announced that it 

had "entered into an agreement with Proxy Governance, Inc. 

C'PG!') to provide proxy voting and advisory services to PGl's 

c1ients.,,92 This announcement went relatively unnoticed and 

neither Glass Lewis's, nor Proxy Governance's web sites have yet 

to reflect this corporate change. In order to provide a complete 

understanding of the proxy advisory industry, we have included the 

©2011 Center On Executive Compensation 36 
92 


81762.055

A Call for Change in the Proxy Advisory Industry Status Quo 

history and services provided by Proxy Governance that will now 

be assumed by Glass Lewis. 

History and Ownership. According to Proxy Governance's 

website, a proxy advisory and voting service was part of the 

original business plan for FOLlOfn, which was founded in 1998. 

That firm started to build a proxy service in 1999 and 2000, but 

those plans were put on hold after the steep market downturn 

following the Sept. 11,2001, terrorist attacks. The PGI website 

says FOLlOfn reinitiated work on the service in 2003, following 

the development of a favorable regulatory environment that would 

expand the market for proxy advisory services. The firm 

completed work on its initial product offering in late 2004, and 

launched its advisory service for the 2005 proxy season. The 

firm's launch was partially financed through a one-year bulk 

subscription agreement with The Business Roundtable, an 

association of CEOs of leading U.S. corporations, on behalf of its 

member companies.93 

Proxy Governance's parent firm, FOLlOfn, Inc., also owns a 

registered broker-dealer, FOLlOfn Investments, Inc., which offers 

an integrated brokerage and technology platform that allows clients 

to purchase and trade customizable portfolios of securities in a 

single transaction. The owners of the parent firm are listed in 

Proxy Governance's 2009 Form ADV as Steven M. H. Wallman, 

MVC Capital, Inc. (a business name for the MEVC Draper Fisher 

Jurvetson Fund I, Inc.) and FISCOP LLC. 94 FISCOP LLC is, in 

tum, majority-owned by Broderick Management LLC, which is 

owned by billionaire investor, Gordon P. Getty95 

Services and Business. Proxy Governance offered proxy 

research, vote recommendations and voting services. On its 

website, the company says that it has developed "a better approach 

to proxy analysis: providing advice with the goal of truly building 

long-term shareholder value.,,96 Rather than looking at issues in 

isolation, the firm says it "evaluates proxy issues and makes voting 

recommendations on an issue-by-company basis, considering a 

company's performance record, business environment, 

management strength, corporate governance and other factors.,,97 

The firm says it offers "a comprehensive range of flexible, Webbased proxy advisory, voting and reporting services.,,98 It says its 

coverage universe is based on the securities held in client 

portfolios and that coverage for some non-U.S. markets is provided 

through partnerships with other proxy advisory firms. In 

particular, Proxy Governance maintained a relationship for 

coverage of many European and Asian securities with Manifest 

Information Services, Ltd., a U.K.-based proxy research and voting 

firm. 

©2011 Center On Executive Compensation 37 
93 


81762.056

A Call for Change in the Proxy Advisory Industry Status Quo 

According to its 2009 Form ADV, Proxy Governance had 

between 11 and 50 employees and less than 100 c1ients.99 Until 

December 20, 2010, Michael Ryan served as the President and 

COO of Proxy Governance, a position he had held since June 

2008. It is unclear wbether Ryan will join Glass Lewis following 

its assumption of Proxy Governance's proxy voting and advisory 

services. 

In early 2010, Proxy Governance began to explore a possible 

cbange in its business model. In a concept summary it made 

available to some industry participants in June 2010, the firm said 

it was considering a "radical change" to restructure itself into a 

non-profit entity called tbe Proxy Governance Institute.loo The 

concept summary stated that the "current for-profit business model 

is a barrier to serving the full range of investors, including 

individual investors" and that a superior approach would be "to 

redeploy PG's services in a new business model sup~orted by user 

fees and supplementcd by third-party sponsorship." I I 

The summary noted that investors and issuers spent hundreds 

of millions of dollars annually preparing and distributing proxies 

and soliciting votes, but said that the business opportunities for 

providing access to corporate governance and voting services were 

"substantially narrower than the wide-ranging need for these 

services. As a result, many investors especially individual 

investors and small and medium-size institutions - are unserved or 

underserved," the summary said. 102 The proposed new entity 

would serve institutional and individual investors, not provide 

consulting services to issuers and "offer basic corporate 

governance and proxy voting services for free and reduced 

COSt."I03 The new institute would have a transparent proxy voting 

policy that was subject to public comment, would provide "due 

process" to enable shareholder proponents and issuers to appeal 

recommendations, and would have a Board of Governors 

comprised of investors, issuers and directors.,o4 

D. Egan-Jones Proxy Services 

Egan-Jones Proxy Services was incorporated in 2002 to 

provide proxy advisory services. The firm is not registered as an 

investment advisor with the SEC although its parent firm is 

registered with the SEC as a Nationally Recognized Statistical 

Rating Organization (NRSRO). 

©2011 Center On Executive Compensation 38 
94 


81762.057

A Call for Change in the Proxy Advisory Industry Status Quo 

History and Ownership. Egan-lones Proxy Services is a 

division of Egan-lones Ratings Company, which was founded in 

1994. The firm is based in Haverford, Pennsylvania. The 

founding principals of the firm are Sean l. Egan and Bruce Jones. 

Egan is a former banker who worked at Chemical Bank (now part 

of lP. Morgan Chase & Co.) and then with KPMG as a consultant 

to banks before starting a research firm called Red Flag Research 

in 1992. Egan hired Jones, a former Moody's analyst, and the firm 

was renamed Egan-Jones and issued its first ratings in 1995. 105 

Egan-Jones Ratings differs from the largest credit rating 

agencies, including Standard & Poor's Corp. and Moody's 

Investors Service, in that it is not paid by issuers to rate securities, 

but solely by institutional investors. In 2008, the firm was granted 

status as a NRSRO by the SEC. 106 Egan-Jones Ratings Services 

has approximately 400 institutional investor clients, but it is not 

known how many of these utilize the firm's proxy service. 107 

Current Services and Business. Egan-Jones says on its 

website that it provides proxy research, recommendations and 

voting services for both U.S. and foreign proxy proposals on an 

annual subscription basis, with prices based on the number of 

securities held. It says it offers two sets of voting guidelines so 

clients can choose whether to vote in accordance with Taft-Hartley 

concerns or whether overall shareholder value considerations 

should take precedence. The company says it provides the 

following integrated proxy services: set-up, notification of 

meetings, research and recommendations, voting guidelines and 

client override flexibility, execution of votes. and vote disclosure 

and guidelinesI08 

Egan-Jones indicates that unlike some of its competitors, it is 

"completely independent" and does not receive any compensation 

for proxy consultation services from corporate managers or board 

members and is therefore better able to represent shareholders and 

Taft-Hartley clients' interests.I09 The company says that it has a 

"deep bench of very experienced credit risk analysts" from its 

credit ratings business and, therefore, when proxy votes involve 

corporate finance issues, its experts can "scrutinize these numbers 

with a trained eye instead of just accepting management's 

expectations.,,110 The company also says it is revolutionizing the 

proxy industry with low fees and transparent pricing, including a 

flat fee of$12.50 per company per year for all clients. 

©2011 Center On Executive Compensation 39 
95 


81762.058

A Call for Change in the Proxy Advisory Industry Status Quo 

E. Other Proxy Advisors 

Although the proxy advisor market is dominated by ISS and 

Glass Lewis, there are niche players that are able to carve out small 

markets for themselves. Examples include Marco Consulting 

Group, which has concentrated primarily on Taft-Hartley funds, 

and the Sustainable Investments Institute, which concentrates on 

research for academic institutions endowment funds. 

Marco Consulting Group. Marco Consulting Group, Inc. 

(MCG) is an Illinois corporation, that provides consulting and 

investment advice to jointly-trusteed plan sponsors, primarily TaftHartley pension plans. The firm, which has offices in Chicago and 

Boston, was founded by Jack M. Marco in 1988. Marco, who 

continues to serve as chairman of the MCG, owns more than 50 

percent of its stock, according to the firm's most recent SEC Form 

ADV.III MCG has been registered as an investment adviser with 

the SEC since 1989. On its website, MCG says it is the largest 

consultant to jointly-trusteed benefit plans in the U.S. with more 

than 350 clients. 

Marco Consulting says it offers a proxy advisory service to its 

Taft-Hartley clients that "reviews each proxy issue with final 

decisions based on the merits of each case and with the best 

interest of the plan's participants and beneficiaries in mind.,,112 

The firm's website lists six employees who work in its proxy 

voting division, which is headed by Greg Kinczewski, VP and 

General Counsel of Marco Consulting Group. Proxy advisory 

services comprise a small fraction of Marco Consulting Group's 

revenues with approximately 4 percent of the firm's total revenues 

attributable to proxy voting services c1ients.m 

Sustainable Investments Institute. The Sustainable 

Investments Institute (Si2) is a non-profit proxy research firm 

founded in 2009 to provide educational proxy research to 

subscribers. The firm is based in Washington, D.C. Si2 issues 

briefing papers and in-depth company-specific reports and has an 

on-line journal and blog. Its analyses, which focus exclusively on 

social and environmental issues, do not make voting 

recommendations. I 14 It issued its first reports for the 2010 proxy 

season to an initial group of subscribers comprised primarily of 

college and university endowments. Heidi Welsh and Peter 

DeSimone co-founded Si2 with Welsh serving as Executive 

Director of the firm. Both Welsh and DeSimone have previous 

experience in the proxy advisory industry with the IRRC and ISS. 

©2011 Center On Executive Compensation 40 
96 


81762.059

A Call for Change in the Proxy Advisory Industry Status Quo 

F. Conclusion 

The proxy advisory finn industry is concentrated primarily in 

two finns - ISS and Glass Lewis - with ISS dominating the 

market. The industry has grown through demand due to the 

increase in proxy votes, acquisition and development of new 

product ideas. However, underlying the growth, especially ofISS, 

is the existence of serious conflicts of interest that call into 

question the finn's voting recommendations. Both ISS and Glass 

Lewis have been identified by corporate issuers as including 

material inaccuracies in some oftheir reports. Yet, despite these 

serious issues, other entrants and participants in the market that do 

not have such issues, at least to the same extent, have only been 

able to playa minor role. 

©2011 Center On Executive Compensation 41 
97 


81762.060

A Call for Change in the Proxy Advisory Industry Status Quo 

V. Conflicts of Interest in the Proxy 

Advisory Industry 

One of the most common and long-standing concerns voiced 

about finns in thc proxy advisory industry is that their business 

models suffer from conflicts of interest. Almost from the time the 

industry was created, proxy advisory finns have bccn criticized for 

providing product offerings or ownership structures that could 

compromise the analyses thcy provide. In 1994, for instance, after 

ISS announced that it would begin consulting with corporations on 

how they might respond to shareholder concerns, Graef Crystal, a 

prominent compensation consultant, put the conflict issue this way: 

They've got a severe conflict when they work both sides of 

the street. It's like the Middle Ages when the Pope was 

selling indulgences. ISS is selling advice to corporations on 

how to avoid getting on their list of bad companies. There's 

a veiled sense of intimidation. 115 

While concerns about conflicts of interest at proxy advisors 

date back decades, these concerns have never bcen resolved and 

continue to attract high-profile attention. Evidencc of the 

continuing high level of concern over this issue includes the fact 

that the U.S. Government Accountability Office (GAO) has twice 

been asked by Congress to study the issue - most recently in 2007 

- and the issue plays a central role in a "concept release" on the 

U.S. proxy system issued by the U.S. Securities and Exchangc 

Commission in July 2010.[16 

Concerns about conflicts of interest in the industry fall into 

four general categories: 

I. Potential conflicts that arise when proxy advisors provide 

services to both institutional investors and corporate issuers on 

the same subjects; 

2. Potential contlicts related to proxy advisors providing 

recommendations on shareholder initiatives backed by their 

owners or institutional investor who are clients; 

3. Potential conflicts when the owners, executives or staff of 

proxy advisory finns have ownership interests in, or serve on 

the boards of, public companies that have proposals on which 

the proxy advisors are making voting recommendations; and 

4. Potential conflicts when proxy advisory finns are owned by 

finns that provide other financial services to various types of 

clients. 

©2011 Center On Executive Compensation 42 
98 


81762.061

A Call for Change in the Proxy Advisory Industry Status Quo 

The Center believes that some of these conflicts need to be 

eliminated and others need to heat least fully disclosed, so that the 

information presented in proxy finn analyses can be placed in the 

appropriate context. The following sections will describe the 

extent to which each of these potential conflicts pertain to the 

major proxy advisory finns and how those finns describe these 

conflicts and the measures they have taken to address them. A 

chart summarizing these conflicts is shown below in Table 2. 

TABLE 2: Types of Potential Conflicts of Interest at Major 

Proxy Advisory Firms 

ISS Glass PGI* Egan- Marco 

Lewis Jones Consulting 

Specialized Consulting Services to X Corporations on Proxy-related Issues 

Makes Recommendations on Proposals X X X X X I Sponsored by Institutional Clients 

Owners, Directors or Officers Serve on X X Public Company Boards 

Proxy Advisor or Corporate Parent Firm X X X X X Provides Other Services to Clients 

* Proxy Governance, Inc. ceased operatIOn on December 31,2010 and transferred Its clIents to Glass LeWIS 

A. Institutional Shareholder Services Inc. (ISS) 

ISS - as the largest proxy advisory firm, with the most lines of 

business, and owned by a major public company is potentially 

subject to all of the categories of conflicts described above. In 

previous analyses of conflicts of interest among proxy advisors, the 

most commonly cited conflict involves a central aspect of ISS's 

business model, which involves providing proxy advisory services 

to institutional investors and, at the same time, providing 

consulting services to corporate clients on how to achieve a better 

governance rating or favorable recommendation on an issue 

covered in the analysis provided to institutions. The 2007 GAO 

study of the proxy advisory industry described this conflict, which 

is a result of the influence ISS has in the market, as follows: 

Because ISS provides services to both institutional investors 

and corporate clients, there are various situations that can 

potentially lead to conflicts. For example, some industry 

professionals stated that ISS could help a corporate client 

©2011 Center On ExeGutive Compensation 43 
99 


81762.062

A Call for Change in the Proxy Advisory Industry Status Quo 

design an executive compensation proposal [company stock 

plan 1 to be voted on by shareholders and subsequently make 

a recommendation to investor clients to vote for this 

proposal. Some industry professionals also contend that 

corporations could feel obligated to subscribe to ISS's 

consulting services in order to obtain favorable proxy vote 

recommendations on their proposals and favorable 

corporate governance ratings. One industry professional 

further believes that, even if corporations do not feel 

obligated to subscribe to ISS's consulting services, they still 

could feel pressured to adopt a particular governance 

practice simply to meet ISS's standards eyen though tbe 

corporations may not sec the value of doing SO.'17 

Similarly, a report by the Millstein Center On Corporate 

Governance, stated that the many companies believe that "signing 

up for [ISS] consulting provides an advantage in how the firm 

assesses their governance" despite ISS disclaimers to the 

contrary."8 Corporate governance expert Ira Millstein has spoken 

harshly of this conflict inherent in the heart of the ISS business 

model: 

I am tbe last person to knock profit-making and the 

capitalist system. I like it. But ISS is in a special position, 

and I query whether profit-making fits well with credible 

private standard-setting. I don't think it does, and this is 

why. ISS has achieved an unusual role for a private profitmaking entity. It provides structural "standards" for corporate governance, privately prepared by unidentified people, 

pursuant to unidentified processes, and asks us to take its 

word that it is all fair and balanced. I tried to dig behind the 

soothing assurances, but couldn't find enough detail to 

convince me that a devil didn't lie in the details of how this 

private standard-setting was put together. And then ISS 

provides company ratings, based on these privately-set 

standards, creating a tendency on the part of those that have 

received a poor rating to pay for a consultancy by the 

private standard-setter, on how to improve that rating. I see 

this as a vicious cycle.l!9 

This particular conflict involving corporate consulting services 

is unique to ISS among the major proxy advisory firms. It has 

received significant attention over the years and has been widely 

criticized by both institutional investors and corporations, who are 

concerned that it drives what is considered "best practice," even if 

the so-called best practice is not in the interest of companies or 

their shareholders. 

©2011 Center On Executive Compensation 44 
100 


81762.063

A Call lor Change in the Proxy Advisory Industry Status Quo 

Concerns about this conflict have also resulted in some loss of 

investor clients, particularly among public pension funds. In 2004. 

for instance, Gary Findlay, the executive director of the Missouri 

State Employees' Retirement System, informed ISS that the 

pension fund was dropping ISS's services over concerns about its 

corporate consulting business. In a letter to ISS quoted in The 

Washington Post, Findlay wrote: "I see no merit in further wasting 

your time or mine regarding this issue. From this point forward, 

we will ... engage an organization that at least has the appearance 

of undivided loyalty to ... clients.'''2o Similar concerns were 

voiced after decisions to drop ISS's proxy service by other major 

funds, including the Ohio Public Employees' Retirement System 

and the Colorado Public Employees' Retirement Association in 

2005 and the Ontario Teachers' Pension Plan in 2006. 121 

ISS provides considerable disclosure on its website of the 

potential conflict created by its business model and the steps it has 

taken to mitigate this conflict. In the Due Diligence Compliance 

Package document posted on its website, ISS says it "is well aware 

ofthe potential conflicts of interest that may exist between ISS' 

proxy advisory service and I CS, and has therefore taken steps to 

prevent any potential conflicts from becoming actual conflicts.,,122 

"ICS" is an acronym for ISS Corporate Services, Inc., a whollyowned subsidiary of ISS that provides corporate consulting 

services. ISS says that key elements of its policies and procedures 

"are designed to ensure the integrity of ISS' institutional proxy 

advisory and advisory research serviees.,,12) Among these 

procedures, ISS says that it "maintains a firewall which separates 

the staffs that perform proxy analyses and advisory research from 

the members ofICS" and that this firewall includes "legal, 

physical and technological separations:·124 ISS also offers a 

"Representation and Warranty" regarding conflicts of interest to its 

subscribers and has a "Code of Ethics" that applies to all 

employees that includes a policy on conflicts of interest. J25 

In spite of the steps it has taken to manage conflicts, 

perceptions remain that ISS's business model is inherently 

conflicted, and ISS's own security filings acknowledge this 

problem. In a 2009 Form lO-K filing [or its then-parent 

RiskMetrics Group Inc., it explicitly acknowledges the significant 

business risk posed by this conflict and the fact that its safeguards 

may not be adequate to manage these conflicts: 

[T]here may be a perceived conflict of interest between the 

services we provide to institutional clients and the services, 

including our Compensation Advisory Services, provided to 

certain corporate clients. For example, when we provide 

©2011 Center On Executive Compensation 45 
101 


81762.064

A Call for Change in the Proxy Advisory Industry Status Quo 

corporate governance services to a corporate client and at the 

same time provide proxy vote recommendations to 

institutional clients regarding that corporation's proxy items, 

there may be a perception that we may treat that corporation 

more favorably due to its use of our services. 

The safeguards that we have implemented may not be 

adequate to manage these apparent conflicts of interest, and 

clients or competitors may question the integrity of our 

services. In the event that we fail to adequately manage 

these perceived conflicts of interest, we could incur 

reputational damage, which could have a material adverse 

effect on our business~ financial condition and operating 

results. 126 

The safeguards implemented by ISS as a firewall between the 

advisory and consulting businesses can only go so far. On its 

website, ISS states that when corporate clients meet with its proxy 

analysis staff, they should refrain from discussing whether the 

company has received consulting services from the other side of 

the company. J27 

Aside from the primary conflict associated with providing 

advisory services to both institutions and corporations, ISS appears 

to be subject to all three of the other types of potential conflicts of 

interest. The recent acquisition of its former parent company, 

RiskMetrics Group, by MSCI Inc. may, if anything, heighten these 

concerns because of the broader range of business interests found 

undcr the MSCI umbrella. According to Julie Gozan, director of 

corporate governance at Amalgamated Bank, a union-owned bank 

that provides investment and trust services to Taft-Hartley pension 

plans and engages in shareholder activism, notes that by going 

public, proxy firms become part of the market itself and can no 

longer solely represent the interests of long-term investors. "The 

community that relies on Glass Lewis and ISS needs to know this 

is unbiased advice that favors long-term investors and not the 

interests of corporate executives," Golan says.128 "When these 

firms go public, there's real potential for a conflict ofinterest.,,129 

©2011 Center On Executive Compensation 46 
102 


81762.065

A Call for Change in the Proxy Advisory Industry Status Quo 

B. Glass, Lewis & Co. 

While Glass, Lewis & Co. does not provide consulting to 

companies and therefore does not have conflicts between proxy 

advisory and corporate consulting work, it is subject to conflicts 

between the company and its corporate owners. 

After being formed as an independent company in 2003, Glass 

Lewis was acquired by Xinhua Finance, a Chinese company, in 

2007. The level of client and staff concerns about Xinhua's 

governance, accounting and potential conflicts of interest were so 

severe that some of Glass Lewis's leadership resigned. These 

conflicts included the fact that Xinhua Finance owned other 

businesses that appeared to pose direct conflicts, including its 

Taylor Rafferty subsidiary, which provided proxy solicitation 

services to corporations. 

Glass Lewis was sold to the Ontario Teachers' Pension Plan 

Board (OTPP) less than a year after its purchase by Xinhua and, 

while the conflicts there are not as severe, questions about the 

firm's ownership continue. OTPP is one of the largest institutional 

investors in Canada administering pension funds for over 

175,000 people - and is one of the most activist public pension 

funds on shareholder and corporate governance activism. On its 

website, OTPP says it promotes "good corporate governance 

standards and practices because we believe they result in better 

long-telm performance.,,130 It is a founding member ofthe 

Canadian Coalition for Good Governance, a membership 

organization of 41 Canadian institutional investors that says it 

"promotes good governance practices in Canadian public 

companies and the improvement of the regulatory environment to 

best align the interests of boards and management with those of 

their shareholders.,,131 The pension system was also a founding 

educational partner in the Institute of Corporate Directors (ICR), 

which describes its mission as fostering "excellence in directors to 

strengthen the ~overnance and performance of Canadian 

corporations." 1 2 

One concern about Glass Lewis' ownership by OTPP relates to 

the highly active role that OTPP plays in major corporate 

financings, restructurings and relationship investing - where an 

investor takes a major ownership stake in companies and partners 

with the management team in a long-term relationship. The 

pension plan's private equity arm, called Teachers' Private Capital, 

had $10 billion in invested capital at year-end 2009 and holds 

significant ownership stakes in dozens of companies. At the same 

time, the pension plan's public equities segment has a Relationship 

Investing Team that takes stakes ranging from 5 to 30 percent in 

©2011 Center On Executive Compensation 47 
103 


81762.066

A Call for Change in the Proxy Advisory Industry Status Quo 

midcap to largecap companics. "As a significant shareholder, we 

take a hands-on approach with our investments," OTPP says. "We 

seek to develop relationships with the board and managcment of 

these companies, and to playa role in effecting strategies and 

changes that will improve the long-term value of our 

investment.,,133 Some observers have questioncd whether Glass 

Lewis will be able to make independent judgmcnts on issues wbcre 

OTPP has a major ownership stake. They also wonder whether 

OTPP's internal governance and voting policies will override those 

developed by Glass Lewis. 

Glass Lewis provides a conflict of interest disclosure statement 

on its website, which highlights that the firm does not offer any 

corporate consulting services. "We are not in the business of 

advising public companies on their governance structures or 

conduct, and we refuse to use our position as trusted advisor to 

institutional investors to win consulting mandates with issuers," it 

states.]34 The firm also notes that it has formed an independent 

Research Advisory Council to insure that the firm's research 

"continues to meet the quality standards, objectivity and 

independence criteria set by Glass Lewis' outstanding research 

team leaders and excludes involvement by the compan;;'s owners 

in the making of Glass Lewis' proxy voting policies.'" 5 The 

Research Advisory Council was announced shortly after the 

departure of two senior Glass Lewis executives after the 

acquisition of the firm by Xinhua Finance. 

Regarding the potential for conflicts of interest stemming from 

its owncrship by OTPP, Glass, Lewis & Co. says: 

aTPp is not involved in the day-to-day management of 

Glass Lewis. Glass Lewis operates and will continue to 

operate as an independent company separate from OT?P. 

The proxy voting and related corporate governance policies 

of Glass Lewis are separate from aTPP. In instances where 

Glass Lewis provides coverage on a company in which 

aTP? holds a stake significant enough to have publicly 

announced its ownership in accordance with the local 

markefs regulatory requirements or Glass Lewis becomes 

aware of aTPP's disclosure to the public of its ownership 

stake in such company, through aTPp's published annual 

report or any other publicly available infonnation disclosed 

by aTPp, Glass Lewis will make full disclosure to its 

customers by adding a note to the relevant research report.'36 

In spite of the firm's insistence that it maintains its 

independence and will disclose any conflicts, concerns about the 

relationship between Glass Lewis and OTPP persist. As one 

commenter summarized the issue: 

©2011 Center On Executive Compensation 48 
104 


81762.067

A Call for Change in the Proxy Advisory Industry Status Quo 

It's hard to believe, however, that there will be no 

connection between the two entities, ... Earlier this year, 

rOT??] lead a private equity group that bought Montrealbased communications giant BCE Inc., the biggest corporate 

takeover in Canadian history. So how is Glass Lewis going 

to evaluate the corporate governance practices of BCE? 

Indeed, how would it rate the practices of any company 

where Teachers' has a major investment? And what if 

Teachers' wants to take over another company? What will 

the Glass Lewis recommendation be to shareholders? No, it 

just doesn't wash. Either Teachers' sells Glass Lewis to a 

company that can legitimately argue that there is no potential 

for conflicts of interest, or boards and shareholders should 

discount and even ignore anything that G lass Lewis says. In 

today's climate of heightened sensitivity, if conflicts of 

interest are not good for chief executive officers or boards of 

directors, they're also not good for the people who police the 

markets. 137 

Concerns about conflicts of interest at Glass Lewis, within 

some segments of the market, are heightened by the fact that the 

firm has been less open in sharing draft reports with corporations 

and provides less transparency regarding its models than some 

other proxy advisory firms. 

C. Proxy Governance, Inc. 

As noted earlier, on December 20, 20 I 0, it was announced that 

Proxy Governance, Inc. (POI) will no longer provide proxy voting 

or advisory services beginning in 2011. 138 Glass Lewis has made 

an agreement with PGI to assume all ofPGl's customer contracts. 

Despite the fact that PGl's operations recently ceased, there were 

potential conflicts of interest there as well. The discussion of these 

contlicts has been included in order to demonstrate how pervasive 

conflicts are in this industry. 

Concerns about potential conflicts of interest at POI have 

centered on the fact that an initial bulk SUbscription agreement 

from a business organization helped to finance the launch of the 

firm's proxy advisory service as well as the potential for conflicts 

involving its parent firm, FOLIOfn. 

The concern over PGl's initial funding received prominent 

news attention in 2006, when a business columnist for The New 

York Times wrote an article mentioning that POI's first 

subscriptions had been from members of The Business Roundtable 

(BRT), an organization representing the CEOs of large 

corporations. The article further suggested that a PGI 

recommendation endorsing a slate of directors at Pfizer might have 

©2011 Center On Executive Compensation 49 
105 


81762.068

A Call for Change in the Proxy Advisory Industry Status Quo 

been influenced by the fact that Hank McKinnell, the CEO of 

Pfizer, was serving as the chairman of The Business Roundtable, 

and that William Steere, Jr., Chairman Emeritus of Pfizer and a 

director at that firm, also served on an advisory policy council at 

Proxy Governance. 139 The article also quoted from a 2004 memo 

written by McKinnell in his capacity as chairman of the BRT, 

urging its members to help Proxy Governance thrive in the 

marketplace by using its services. 

The column in The New York Times appeared after the original 

bulk sUbscription agreement between Proxy Governance and the 

BRT had already expired. POI publicly refuted the argument that 

its connections to the BRT or Pfizer had any impact on its Pfizer 

vote recommendation, but the article led to lingering questions 

from some institutional investors about PGl's ties to the business 

community and the degree of independence of its voting 

recommendations. 

While no specific concerns about the ownership of PGl by 

FOLIOfn have surfaced in news reports or the academic literature, 

the relationship appeared to hold the potential for conflicts of 

interest. The GAO study on proxy advisors, for instance, notes 

that at proxy advisory firms where the parent company offers 

financial services to various types of clients, these relationships 

"may present situations in which the interests of different sets of 

clients diverge.,,14o Some observers have also speculated that, 

because FOLIOfn and its broker-dealer subsidiary provide services 

that compete with the mutual fund industry, the relationship made 

it more difficult for POI to attract mutual fund clients, which 

comprise a large part of the market demand for proxy advisory 

services. 

At the time of the announcement that it was ceasing operations, 

Proxy Governance's public website did not contain a public 

disclosure statement regarding its policies toward conflicts of 

interest. The website did note the original bulk subscription 

agreement with the BRT as well as the firm's relationship with its 

parent company, FOLIOfn. As a registered investment adviser, 

Proxy Governance's Form ADV filing also provides some 

information about the firm's ownership and potential conflicts.141 

The company also had employee policies that addressed conflicts 

of interest. 

©2011 Center On Executive Compensation 50 
106 


81762.069

A Call for Change in the Proxy Advisory Industry Status Quo 

D. Egan-Jones Proxy Services 

Egan-Jones Proxy Services is subject to potential conflicts of 

interest related to its ownership by Egan-Jones Ratings Co., a 

credit ratings agency. Egan-Joncs Ratings Co. has garnered 

considerable pUblicity for the fact that among accredited ratings 

agencies, it is virtually alone in adopting a policy of accepting 

compensation only from the users of its services, institutional 

invcstor subscribers, rather than from corporate issuers seeking 

ratings. Some observers note, howevcr, that this stance does not 

necessarily eliminate all conflicts, because subscriber-supported 

credit ratings agencies may have incentives to issue ratings that 

cater to the wishes of their largest investor clients, including hedge 

funds that utilize short-selling strategies.142 Egan-Jones Ratings 

Co. acknowledged that it has a material conflict of interest with 

subscribers in its application to become a nationally-recognized 

statistical rating organization (NRSRO), stating: 

Egan-Jones is paid by persons for SUbscriptions to receive or 

access the credit ratings of Egan-Jones andlor for services 

offered by Egan-Jones where such persons also may own 

investments or have entered into transactions that cou1d be 

favorably or adversely impacted by a credit rating issued by 

Egan_Jones. 143 

The finn goes on to state, however, that it does not believe this 

conflict applies to its proxy services unit: 

In addition to providing credit rating services, Egan-Jones 

may provide proxy services to certain subscribers. EganJones believes that providing these services to subscribers of 

its credit rating services does not present material conflicts 

of interest of the types contemplated in Exhibit 6, 

particularly since these subscribers are not also issuers that 

are being rated (or whose securities are being rated) by 

Egan-Joncs. l44 

The website for Egan-Jones Proxy Services emphasizes that the 

finn is independent and does not offer corporate consulting 

services, but contains only a brief reference to conflicts of interest. 

Regarding conflicts, the website states that "[ u ]nlike many of our 

competitors, Egan-Jones does not receive any compensation for 

proxy consultation services from corporate managers or board 

members and is therefore better able to represent shareholders and 

Taft-Hartley clients' interests.,,145 Similarly, the website for EganJones Ratings Services says that the firm has no conflicts of 

interest because it receives no compensation from issuers to rate 

their securities. 146 

©2011 Center On Executive Compensation 51 
107 


81762.070

A Call for Change in the Proxy Advisory Industry Status Quo 

E. Union-Affiliated Proxy Advisors 

Concerns about conflicts of interest at union-atliliated proxy 

advisors, such as Marco Consulting Group, stem [rom the [act that 

these firms' clients are Taft-Hartley pension funds that are also 

often active sponsors of shareholder proposals. This raises the 

concern that union-atliliated proxy advisors will always feel 

beholden to support proposals made by their Taft-Hartley clients. 

A study on voting integrity by the Millstein Center on Corporate 

Governance raises the issue as follows: 

Every year Marco's union clients sponsor a number of 

shareholder proposals. Most of these are in line with 

Marco's own proxy voting guidelines, but occasionally one 

is proposed that is contrary to their principles. Marco is then 

left in the potentially embarrassing position of 

recommending a vote against a proposal sponsored by one of 

its own clients. Marco seeks to limit the appearance of 

conllicts in such a situation by maintaining very 

comprehensive and specific proxy voting policies which 

make clear how the consultant would cast its vote under the 

circumstances. However. the possibility, though remote. that 

Marco could compromise its independence to satisfy clients 

causes concern to some. 147 

Regarding conflicts, Marco Consulting Group's public website 

states that "[sJince MCG does not render consulting services to the 

corporate or investment management communities, it has no 

conflicts of interesl.,,148 The firm is also registered as an 

investment adviser and files a Form ADV statement that provides 

some information about ownership and potential conflicts. 149 

F. Parallels to Identified Conflicts at Credit Ratings 

Firms 

Conflicts of interest at proxy advisory firms while decades 

old have recently become the subject of renewed scrutiny as part 

of an overall effort to increase transparency and restore confidence 

in the financial services sector ofthe economy. Some oflhis 

renewed interest is almost certainly due to the intense spotlight 

shined by the press, Congress and the SEC on the prominent role 

that conflicts of interest within the credit ratings industry played in 

fostering the credit and mortgage crisis that has engulfed the U.S. 

economy in recent years. Conflicts of interest at credit ratings 

agencies have been the focus of hearings, legislation, 

investigations and other actions from dozens of federal and 

international agencies and organizations. Among the U.S. 

government agencies and organizations that have taken actions on 

the issue are: Congress, the Financial Crisis Inquiry Commission, 

©2011 Center On Executive Compensation 52 
108 


81762.071

A Call for Change in the Proxy Advisory Industry Status Quo 

the SEC, the U.S. Treasury Department, the Federal Reserve, the 

U.S. Department of Justice, the Federal Bureau oflnvestigation, 

the New York Insurance Department and the New York and 

California Offices of Attorneys General. 

The results of this intense scrutiny, while still unfolding, 

include the establishment of almost an entirely new regulatory 

framework for credit ratings agencies in the Dodd-Frank Act. 

These regulatory changes are grounded in Congressional findings 

that the activities and perfonnance of credit ratings firms, or 

NRSROs, are "matters of national public interest, as credit ratings 

agencies are central to capital fonnation, investor confidence, and 

the efficient perfonnancc of the United States economy.,,150 

Recently, some observers have drawn parallels between the 

detrimental impacts to the economy that unfolded from widely 

acknowledged but largely unaddressed conflicts of interest at 

credit ratings finns and the current situation in the proxy advisory 

industry. The SEC highlighted this analogy in its July 2010 

concept release requesting comments on the U.S. proxy system, 

where it stated that "in light of the similarity between the proxy 

advisory relationship and the 'subscriber-paid' model for credit 

ratings, we could consider whether additional regulations similar to 

those addressing conflicts of interest on the part of Nationally 

Recognized Statistical Rating Organizations ("NRSROs") would 

be useful responses to stated concems about conflicts of interest on 

the part of proxy advisory finns." 151 

A 2009 study on the credit ratings agencies by the 

Congressional Research Service listed a number of perceived 

reasons for the industry's failings. 152 They included: 

business model bias; 

the existence of a quasi-regulatory license; 

flawed models and assumptions; 

an inability to handle a voluminous amount of business; 

challenges from high levels offraud and lax mortgage 

underwriting; 

insufficient regulation; 

conflicts of interest involved in both rating and helping to 

design the same securities; 

conflicts of interest in the provision of ancillary services to 

issuers whose securities they rate; and 

limited liability under the First Amendment.153 

©2011 Center On Executive Compensation 53 
109 


81762.072

A Call for Change in the Proxy Advisory Industry Status Quo 

While not all of these conditions apply exactly to the proxy 

advisory industry or to each of the finns in it, what is striking is the 

number of parallels between the two industries. Section VII of this 

study will discuss how the regulatory regime imposed on credit 

ratings agencies may be applicable to the proxy advisory industry. 

©2011 Center On Executive Compensation 54 
110 


81762.073

A Call for Change in the Proxy Advisory Industry Status Quo 

VI. Impact of Significant Inaccuracies 

and Lack of Transparency in Proxy 

Analyses 

One of most troubling developments with respect to proxy 

advisory firm analysis is the number and scope of inaccuracies in 

the research reports they produce on corporate issuers and a 

general lack of transparency in many of the methodologies, metrics 

and decision processes utilized by them to make voting 

recommendations, Because proxy analysis is largely concentrated 

in a few firms, the potential impact of these inaccuracies on the 

proxy voting system is substantiaL Moreover, this is compounded 

when the substantial increase in the volume of votes and the import 

of those votes is considered, Recent survey data from the Center 

On Executive Compensation, presented below, highlights the 

frequency and types of inaccuracies found in proxy analyses on 

compensation issues, This chapter will also discuss potential 

reasons for the inaccuracies, and the potential impact of the lack of 

transparency on voting outcomes. 

A. Potential Reasons for Inaccuracies 

A number of reasons have been proffered for the significant 

level of inaccuracies found in reports produced by the proxy 

advisory industry. The most frequently cited reasons are lack of 

adequate resources and quality control procedures, pressures on the 

industry to reduce costs and the extremely short turnaround time 

available for proxy analyses. 

Lack of adequate resources and quality control. Perhaps 

the greatest reason why errors and inaccuracies have proliferated in 

proxy analyses is a lack of resources to deal with the sheer volume 

of data and information processed by these firms. The largest 

proxy advisor, ISS, claims it provides proxy analysis on nearly 

40,000 company meetings in more than 100 developed and 

emerging markets worldwide. The collection and processing of 

data for these companies encompassing management and 

shareholder proposals, financial perfonnance, compensation plans 

and amounts, officers and directors, boards and board committees, 

anti-takeover and bylaw provisions, auditors, social and 

environmental performance and other governance issues is a 

monumental task. 

©2011 Center On Executive Compensation 55 
111 


81762.074

A Call for Change in the Proxy Advisory Industry Status Quo 

Perversely, the trend toward regulators requiring greater 

volumes of disclosure by companies and more corporate 

accountability to shareholder votes, particularly in the United 

States and Europe, has greatly expanded the information 

processing and analytic requirements needed to assess proxy 

issues. 

To take one recent example, the SEC issued new rules in 2006 

requiring companies to disclose considerably more information in 

the Compensation Discussion and Analysis (CD&A) sections of 

their proxy statements regarding various key elements of 

compensation policies, practices, objectives and performance, 

along with seven specific tables of compensation data. The new 

rules have unquestionably multiplied the amount of quantitative 

and qualitative data available to investors to assess corporate 

compensation issues. But the CD&A section in large company 

proxy statements has now grown to an average of 26 pages. 1S4 As 

a consequence, a proxy advisory firm, such as ISS, that attempted 

to cover more than 10,000 domestic companies (or a large and 

highly indexcd investing institution that attempted to do its own 

compensation analysis) could potentially face the prospect of 

reading and digesting hundreds of thousands of pages of CD&A 

discussion and compensation tables merely to understand company 

compensation plans and practices and that does not account for 

any independent analysis of these arrangements. 

Extrapolating this single example of how proxy research needs 

have snowballed from CD&A filings to the other disclosures that 

have been, or are in the process of being, required by the SEC in 

proxy statements - including those on audit firms and procedures, 

use of compensation consultants, director qualifications, risk 

management and oversight and board leadership makes it easy to 

comprehend why many institutional investors have chosen to 

outsource corporate governance and proxy research. 

To cope with the massive amount of data collection and 

analysis required to analyze proxy issues at thousands of 

companies, the proxy advisory firms have, in turn, largely 

outsourced their own "data mining" operations. As noted in 

Chapter III, ISS maintains a data collection and research operation 

center in the Philippines with more than 150 employees. Other 

proxy advisors utilize third-party contract firms, some of them 

located overseas, to procure and extract proxy statement 

information from public company filings. 

The need to collect ever greater amounts of data and the trend 

toward outsourcing this task no doubt contribute to the potential 

for errors in proxy research. In addition, because of the seasonal 

nature of proxy analysis work, with a large fraction of U.S. public 

©2011 Center On Executive Compensation 56 
112 


81762.075

A Call for Change in the Proxy Advisory Industry Status Quo 

company proxy filings taking place in a few months in the spring 

of each year, a considerable amount of the data collection and 

analysis work that remains is handled by temporary employees at 

the major proxy advisory firms. As participants in an investor 

roundtable sponsored by the Millstein Institute for Corporate 

Governance and Perfonnance noted, this heavy reliance on 

temporary employees inevitably has led to concerns about the 

quality of the services being performed: 

Nevertheless, there is concern whether someone who may 

have limited, or no, business or proxy experience can make 

infonned and appropriate voting recommendations. More 

than one investor present was uneasy about whether relying 

on the advice of inadequately resourced providers meant that 

they were not properly discharging their duties.''' 

Industry cost pressures. The problem of a lack of adequate 

resources to prevent errors and inaccuracies in proxy research 

reports has likely been exacerbated in recent years by pressures on 

the proxy advisory firms to increase profitability in order to service 

debts incurred in their acquisitions (in the case of the largest firms) 

or to stem operating losses (at smaller firms). MSCI, for instance, 

announced in a regulatory filing in July 20 I 0 that it was 

eliminating 70-80 jobs in a "first round" of cuts associated with its 

purchase of RiskMetrics Group and that a second round of 

restructuring changes was expected to be completed by the end of 

the first quarter of 2011. 156 

Short turnaround time for analyses. Another frequently 

mentioned reason for inaccuracies in proxy analyses is the very 

tight time-frame under which proxy advisory firms operate in 

producing their reports for clients. Under corporate state law, 

issuers must generally provide written notice to shareholders of the 

annual meeting within a fixed number of days before the date of 

the meeting. 

For instance, Delaware corporate law requires notice of the 

annual meeting at least 10 days, but no more than 60 days, before 

the meeting. Under federal regulations, issuers using internetbased distribution of proxy materials must post these materials at 

least 40 days before the meeting date. But many institutional 

investors expect proxy advisory firms to provide them with 

research reports on matters to be voted on at annual meetings at 

least several weeks before the meeting date. Therefore, proxy 

advisory firms typically have a narrow window of time between 

when they obtain access to many proxy statements and when their 

reports must be made available to clients. 

Within this window, some - but not all- proxy advisory firms 

endeavor to make draft reports available to companies in order to 

©2011 Center On Executive Compensation 57 
113 


81762.076

A Call for Change in the Proxy Advisory Industry Status Quo 

allow companies to comment on these drafts and any inaccuracies 

in them. A frequent complaint from issuers, however, is that the 

proxy advisory firms that do havc such review procedures require 

any comments back from issuers within an unrealistic one- or twoday time-frame, which may occur over a weekend. 

B. Center On Executive Compensation Research on 

Inaccuracies 

The Center On Executivc Compensation and its parent 

organization, HR Policy Association, conducted two member 

surveys in 20 I 0 designed to gather data on the prcvalence of 

inaccuracies in research by the proxy advisory firms on 

compensation-related matters. 

In one survey, conducted in August 2010, the HR Policy 

Association survcyed Chief Human Resource Officers regarding 

various aspects of their companies' experiences with proxy 

advisory firms. Of those responding, 53 percent said that a proxy 

advisory firm had made one or more mistakes in a final published 

report on the company's compensation programs. The most 

common types of inaccuracies found were: improper peer groups 

or peer data (19%), erroneous analysis of long-term incentive plans 

(17%), and inaccurate discussion ofa company policY'lilan or 

benefit based on provisions no longer in effect (15%).1 

In response to a question about whether proxy advisory firms 

were using proper peer groups in evaluating compcnsation, 57 

percent of survey respondents said that a proxy advisory firm had 

used a compensation peer group in a preliminary draft of a report 

that failed to take into account the company's size, industry, 

complexity or competition for talent. Of the firms that indicated 

the use of such an inappropriate peer group, 96 percent indicated 

that th~geer group was not adjusted in the final version of the 

report. 

Proper selection of industry peers is a critical component of 

pay analysis, because peer groups are heavily relied upon by both 

compensation committees and proxy advisory firms in their 

analysis of executive compensation. At companies where proxy 

advisory firms deem compensation to be excessive relative to 

industry peers and to performance, proxy advisors often 

recommend that investors withhold voting in favor of board 

nominees who serve on the compensation committee. 

Similarly, in a February 2010 survey of its Subscribers, the 

Centcr asked about the types of inaccuracies companies had 

experienced in 2008 or 2009 in a draft version of a proxy advisory 

service report regarding compensation programs. A sample of the 

©2011 Center On Executive Compensation 58 
114 


81762.077

TABLE 3: 

A Call for Change in the Proxy Advisory Industry Status Quo 

descriptions provided by companies of these inaccuracies is shown 

below in Table 3. 159 

Sample Compensation-Related Inaccuracies 

Reported by Center On Executive Compensation 

Members in 2010 Survey 

ISS and Glass Lewis significantly misstated the stock value of 

three of our executives from the Summary Compensation 

Table in 2008. 

We experienced six inaccuracies in ISS' draft report for the 

2009 proxy season. They related to the following: (i) vesting of 

performance shares, (ii) disclosure of non-equity bonus 

targets, (iii) incorrect attribution of aircraft gross-ups to one 

officer, (iv) payment of dividend equivalents on unvested 

performance share awards, (v) performance share targets at 

which payouts are made, and (vi) stating that our CEO was 

"entitled" to use company aircraft for personal travel, when in 

fact he is to do so. 

Both Proxy Governance and ISS miscalculated the total 

compensation by using the maximum opportunity for our 

performance share plan grant (three times fair market value on 

date of grant) compared with the target. Proxy Governance 

did make the correction; however, ISS did not correct the 

but added language to their report about the 

rule. 

We found problems in report and told them, but they did not fix 

the discrepancies with the items in our proxy. When we asked 

them about it later, their response was that they only change 

items that they feel are significant or pertinent to the 

shareholders' understanding of the information provided in the 

report. 

In 2009, Glass Lewis elected to withhold against reelecting our 

Compensation Committee members based on our pay 

compared to their peer group. We noted that their analysis 

was based on our 2008 data versus the peer 2007 data. 

ISS' draft last year was obviously a cut and paste from their 

report on another company as it included negative language 

about personal use of the company aircraft. Although we 

lease a fractional share of an aircraft, there was no personal 

use of the aircraft executive. 

Glass Lewis did not calculate "pay for performance" correctly 

which led to a "0" 

ISS characterized one gross-up on a perk as though it were a 

current, ongoing benefit that applied to everyone. We 

corrected them stating that the gross-up provision has been 

discontinued prospectively. 

Source: Center On Executive Compensation survey, February 2010 

©2011 Center On Executive Compensation 59 
115 


81762.078

A Call for Change in the Proxy Advisory Industry Status Quo 

C. Lack of Transparency in Proxy Analyses and 

Recommendations 

In addition to the issue of inaccuracies in their analyses, many 

observers have noted concerns about the lack oftransparency of 

proxy advisors in tenns of their voting detenninations, 

methodologies and their use of proprietary models on issues such 

as compensation. Issuers are concerned that many 

recommendations from proxy advisors are based on a "one-sizefits-all" governance approach that does not capture the differences 

in company situations or approaches. At the same time, there are 

concerns that proxy advisors utilizing a "case-by-case" or 

individualized approach to their recommendations can be 

inconsistent in how they treat companies or can be opaque with 

respect to their decision process on any particular issue. 

Similarly, there are concerns that the proxy advisors are 

unwilling to make their models completely transparent. In the area 

of compensation, for example, the major proxy advisory firms rely 

on proprietary models that relate a company's executive pay to 

those of its peers and to the company's perfonnance relative to 

peers. These models form the basis for proxy advisors' 

recommendations regarding many compensation-related ballot 

items. But proxy advisory firms say that many of the parameters 

of these models, such as the weightings of various performance 

factors utilized as inputs into the models, are considered 

proprietary and are not made available publicly. This effectively 

results in a "black box" situation for companies attempting to 

understand why a proxy finn may recommend against their 

compensation plans. 

D. Impact of Inaccuracies and Lack of Transparency on 

Voting Outcomes 

The impact of inaccuracies in reports and the lack of 

transparency in how proxy advisors make their recommendations 

raise serious issues for U.S. capital markets. Because institutional 

investors have come to rely so heavily on the infonnation and 

recommendations provided by proxy advisory firms and because 

proxy votes on many issues, from director elections to approval of 

compensation plans, are no longer perfunctory ratifications of 

management's positions - errors or inaccuracies in proxy reports 

are now capable of causing significant hann to corporations and 

their investors. 

©2011 Center On Executive Compensation 60 
116 


81762.079

A Call for Change in the Proxy Advisory Industry Status Quo 

In recent years, for instance, the percentage of equity plans 

that ISS has recommended voting against has fluctuated between 

30 and 40 percent If any significant percentage of these 

recommendations was based on erroneous or inaccurate data, as 

the Center's survey data discussed earlier suggests, it would imply 

that inaccuracies at ISS are negatively impacting the compensation 

programs at a meaningful number of companies, As noted earlier, 

this influence is poised to grow with the addition of say on pay, 

proxy access and majority voting. 

The seriousness with which many corporations are taking the 

issue of inaccuracies in proxy analyses is illustrated by the fact that 

some companies now feel compelled to respond to inaccuracies in 

proxy reports by filing detailed rebuttals in their own public 

securities filings. For example, in May 2009, Target Corporation 

responded to what it said were numerous inaccuracies in a report 

issued by ISS/RiskMetrics related to a controversial proxy fight at 

Target by issuing a seven page white paper to its shareholders 

discussing what it described as "flaws" in the ISS analysis ofthe 

proxy fight Among the inaccuracies that Target cited in the filing 

were: a mischaracterization of the company's real estate strategy as 

"atypical" among major retailers, a flawed calculation of 

compound annual growth rates, failure to provide full context in 

quoting a corporate .govern~ce e~~ert and mischaracterizing the 

company's nommatmg practIces. 

E. Conclusion 

Proxy advisory firms have a fiduciary duty to provide accurate 

and reliable analyses on executive compensation and governance 

practices of corporate issuers to their institutional investor clients. 

Based on proxy advisory firm reports, corporate issuers are 

increasingly concerned that proxy advisors are transmitting 

inaccurate information to institutional investors that could 

adversely impact investors' decisions on pay and governance 

malters. Because the potential impact on the companies is 

substantial, the Center believes that accuracy of reports should be 

more closely monitored and regulated by the SEC to minimize 

adverse impacts on pay for performance. 

©2011 Center On Executive Compensation 61 
117 


81762.080

A Call for Change in the Proxy Advisory Industry Status Quo 

VII. The Existing Regulatory and Legal 

Framework for Proxy Advisors 

Given the reliance of institutional investors on proxy advisory 

firms, and the importance of proxy voting to the operation of 

capital markets and corporate governance, one would expect that 

the advisory industry would be heavily regulated. However, that is 

not the case. Proxy advisory firms are subject to very little 

regulation. The principal regulatory framework governing the 

industry is the Investment Advisers Act, but proxy advisers can 

essentially choose whether to be covered by the Act's regulations. 

At present, the only real oversight of proxy advisors would 

come from institutional investors, who are required to monitor the 

activities of proxy advisors and ensure the independence of the 

recommendations made by them. Yet, institutional investors have 

little incentive to monitor the advisory firms carefully, since proxy 

advisory firms offer them an efficient and cost-effective way to 

discharge their fiduciary duties to vote proxies in the interest of 

their clients. This section will discuss the existing regulatory and 

legal framework governing the activities of proxy advisory firms. 

A. The Investment Advisers Act of 1940 

The principal legal and regulatory framework governing the 

activities of proxy advisory firms is the Investment Advisers Act of 

1940 (the Act). A person or firm is considered an "investment 

adviser" under the Act if, for compensation, they engage in the 

business of providing advice to others as to the value of securities, 

whether to invest in, purchase, or sell securities, or issue reports or 

analyses concerning securities.161 The SEC has stated that it 

considers proxy advisory firms to meet the definition of an 

investment adviser "because they, for compensation, engage in the 

business of issuing reports Or analyses concerning securities and 

providing advice to others as to the value of securities.,,162 The 

SEC has further stated that, as investment advisers, "proxy 

advisory firms owe fiduciary duties to their advisory clients.,,163 

The U.S Supreme Court has articulated the fiduciary duty of 

investment advisers as a requirement that advisers act in the best 

interest of clients and disclose all conflicts of interest. 164 The SEC 

has also stated that a "proxy advisory firm has a duty of care 

requiring it to make a reasonable investigation to determine that it 

is not basing its recommendations on materially inaccurate or 

incomplete information.,,165 

©2011 Center On Executive Compensation 62 
118 


81762.081

A Call for Change in the Proxy Advisory Industry Status Quo 

Although proxy advisory finns meet the definition of 

investment advisers, they have some discretion whether to register 

under the Advisers Act. The Act contains a prohibition against 

registering with the SEC for firms that have less than $25 million 

in assets under management a provision Congress established in 

1996 to divide regulatory responsibility for advisers between the 

SEC and the states. '66 Within a year of the recent passage of the 

Dodd-Frank Act, this threshold will rise to $100 million for most 

investment advisers if they are subject to regulation and 

examinations in their home states. This prohibition would apply to 

most proxy advisors because they typically do not manage client 

assets. 

To make matters more confusing, the prohibition is subject to 

several exemptions, including one that allows firms to register if 

they serve as consultants to pension plan clients with a minimum 

0[$50 million in assets. 167 As of December 2010, three proxy 

advisory finns - ISS, Proxy Governance and Marco Consulting 

Group -were registered with the SEC as investment advisers using 

this "pension consultant" exemptionI68 

Some provisions of the Investment Advisers Act apply to 

proxy advisory linns regardless of whether they have registered 

with the SEC. In particular, section 206 of the Act prohibits an 

adviser from engaging in "any transaction, practice or course of 

business which operates as a fraud or deceit on any client Of 

prospective client.,,169 Proxy advisors that elect to register as 

investment advisers are subject to a number of additional 

requirements, including requirements to: 

file and make qertain disclosures on an annual Fonn ADV; 

adopt, implement and annually review an internal compliance 

program consisting of written policies and procedures; 

designate a chief compliance officer to oversee its compliance 

program; 

establish, maintain and enforce policies preventing misuse of 

non-public information; and 

create and preserve certain records that are available for SEC 

inspection. 

According to a GAO study of proxy advisors in 2007, the 

SEC's Office of Compliance Inspections and Examinations 

monitors the operations and conducts inspections of registered 

investment advisors, including the registered proxy advisory 

finns. 170 As part ofthese examinations, the SEC stated, it "may 

©2011 Center On Executive Compensation 63 
119 


81762.082

A Call for Change in the Proxy Advisory Industry Status Quo 

review the adequacy of disclosure of a firm's owners and potential 

conflicts; particular products and services that may present a 

conflict; the independence of a firm's proxy voting services; and 

the controls that are in place to mitigate potential conflicts."l7l 

The GAO study noted that it did not independently assess the 

adequacy of the SEC examinations, but that the SEC reported that 

it did not identify any major violations of federal securities laws as 

part of its examinations of proxy advisors and had not initiated any 

enforcemcnt actions against these firms.172 

In May 2009, the SEC did settle an enforcement action against 

an investment adviser, lNTECH lnvestment Management LLC and 

its COO related to that adviser's policies, procedures and failure to 

disclose to clients a material conflict of interest related to its proxy 

voting policies. 173 INTECH had been using a specialized proxy 

service provided by ISS designed to follow AFL-CIO voting 

recommendations. The SEC found that lNTECH had violated 

Rule 206(4)-6 of the Investment Advisers Act, because its written 

policies and procedures did not address material conflicts that 

arose between lNTECH's interests and those of its clients who 

were not pro-AFL-CIO, and that it did not sufficiently describe to 

clients its voting policies and procedures. INTECH settled the 

case after consenting to a cease-and-desist order and the payment 

of civil penalties of $300,000 by the company and $50,000 by its 

COO. 174 

The lNTECH settlement is important, because it establishes 

that the SEC is prepared to enforce the duty that exists for 

institutional investors to monitor the conflicts of interest that can 

arise in their own proxy voting policies and procedures. It does 

not speak directly, however, to the willingness of regulators to take 

enforcement actions against the proxy advisors themselves or 

against institutional investors for failure to monitor the conflicts of 

interest at proxy advisors. 

B. Rules Governing Proxy Solicitation 

The SEC has noted that because of the broad definition of 

"solicitation" under the Securities and Exchange Act of 1934, the 

provision of proxy advice constitutes a solicitation that normally 

would subject the proxy advisory firms to the information and 

filing requirements under the proxy rules in the Exchange Act. In 

1979, however, the SEC adopted a rule exempting proxy advisors 

from these informational and filing requirements, providing that 

certain conditions were met. 

©2011 Center On Executive Compensation 64 
120 


81762.083

A Call for Change in the Proxy Advisory Industry Status Quo 

Specifically, the advisor: 

must render financial advice in the ordinary cOllfse of its business; 

must disclose to its client any significant relationship it has with 

the issuer or any of its affiliates, or with a shareholder proponent 

ofthe malter on which advice is given, in addition to any material 

interest of the advisor in the malter to which the advice relates; 

may not receive any special commission or remuneration for 

furnishing the proxy voting advice from anyone other than the 

recipients of the advice; and 

may not furnish proxy voting advice on behalf of any person 

soliciting proxies.175 

The SEC has noted, however, that while proxy advisory firnlS 

are exempt from the informational and filing requirements 

governing proxy solicitation, they remain subject to an Exchange 

Act prohibition against false and misleading statements. 176 

C. Fiduciary Duty Only to Clients 

Although the SEC has stated that proxy advisory firms owe 

fiduciary duties to their clients, some observers and legal scholars 

have questioned whether, in practice, such duties serve as any real 

restraint on the proxy advisory industry. Corporate managers and 

directors owe clear fiduciary duties of care and loyalty to the 

corporation and its stockholders, which are designed to prevent the 

abuse of power by agents of the corporation. As Delaware Vice 

Chancellor Leo Strine has noted, however, "[u]nlike corporate 

managers, neither institutional investors, as stockholders, nor ISS, 

as a voting advisor, owe fiduciary duties to the corporations whose 

policies they seek to influence.,,177 According to one law 

professor, therefore, the trend toward institutional investors' 

greater reliance on the voting recommendations of proxy advisors, 

as opposed to those of corporate managers, essentially means they 

arc "replacing agents who are constrained by relatively strong 

fiduciary duties with an agent who has relatively weak fiduciary 

duties.,,178 

The Department of Labor (DOL) has recently inserted itself 

into the regulatory landscape of proxy advisors. On October 22, 

2010, DOL proposed regulations that will expand the categories of 

individuals who would be considered fiduciaries under the 

Employee Retirement Income Security Act of 1974, as amended 

(ERISA)n9 The plain language ofthe regulations indicates that 

ISS and Marco Consulting would fall within the purview of the 

regulations as they are SEC-registered investment advisers to the 

extent the proxy advisor effectively exercises discretion over the 

©2011 Center On Executive Compensation 65 
121 


81762.084

A Call for Change in the Proxy Advisory Industry Status Quo 

proxy voting decisionl80 The Preamble to the proposed 

regulations, however, specifically notes that "[the provision would 

apply to 1 advice and recommendations as to the exercise of rights 

appurtenant to shares or stock (e.g., voting proxies) ... ,,181 It is 

unclear how the proposed regulations will be interpreted and 

whether they will apply only those firms registered as investment 

advisors with the SEC or all proxy advisory firms. 

The implications of the proposed regulations are extensive. If 

finalized, proxy advisory firms would arguably become subject to 

the wide range of fiduciary duties and obligations under ERISA, 

such as the duties of loyalty and prudence, and would be prohibited 

from engaging in self-dealing transactions. ERISA imposes 

significant civil penalties and excise taxes for fiduciary violations. 

As such, categorizing proxy advisory firms as ERISA fiduciaries 

may cause the ISS business model to become obsolete as the 

business model itself presents inherent conflicts of interest. 

ERISA would certainly consider it a breach of fiduciary duties for 

a firm, such as ISS, to provide consulting services to a corporate 

client at the same time that ISS is providing another client with 

"independent" proxy voting research and recommendations about 

the corporate client receiving consulting services. Until final 

regulations are released, we can only speculate as to whether and 

the extent of the regulatory framework that will be imposed upon 

proxy advisory firms under ERISA. 182 

©2011 Center On Executive Compensation 66 
122 


81762.085

A Call for Change in the Proxy Advisory Industry Status Quo 

VIII. Proposals Addressing Proxy 

Advisor Conflicts and Lack of 

Transparency 

Proxy advisory finns playa central role in the proxy voting 

process and wield significant influence over the structure of 

executive compensation and corporate governance at most 

eompanies. Lacking sufficient regulatory oversight, the industry 

has developed organically. As a result, significant problems have 

developed regarding conflicts of interest, lack of transparency and 

analytical inaccuracies that could have a detrimental impact on 

shareholder value. 

There is a growing consensus that greater regulation of the 

industry, ranging from elimination of certain conflicts to clearer 

fiduciary responsibility and disclosure regarding their processes, is 

necessary to ensure that the infonnation provided by proxy 

advisors is accurate and reliable. Notably, the International 

Organization of Securities Commissions (IOSCO), the 

international organization of securities regulators, recently revised 

its principles of securities regulation based on the lessons learned 

from the financial crisis and, among its new principles, was one 

directed at organizations like proxy advisors. The IOSCO stated 

that "entities that offer investors analytical or evaluative services 

should be subject to oversight and regulation appropriate to the 

impact their activities have on the market or the degree to which 

the regulatory system relies on them.,,183 This section will analyze 

the leading proposals for remedying the perceived problems at 

proxy advisory finns through greater regulation. 

©2011 Center On Executive Compensation 67 
123 


81762.086

A Call for Change in the Proxy Advisory Industry Status Quo 

A. The Proxy Advisory Industry Should Be Regulated by 

the SEC 

Most proposals calling for increased regulation of the proxy 

advisors recognize the primacy ofthe SEC's regulatory authority 

over the industry. As a result, the most effective approach to 

regulation would be to have the SEC be responsible for additional 

regulation ofthe industry. The SEC has statutory authority over 

proxy advisors, which is highlighted by the fact that it has 

established exemptions for them from various SEC regulations 

such as those governing proxy solicitations - that would otherwise 

impose significant administrative burdens on proxy advisory firms. 

As some observcrs have noted, the SEC could modify these 

exemptions to make their availability contingent on a proxy 

advisor meeting various standards Or conditions. The SEC already 

has direct regulatory authority over two proxy advisors·- ISS and 

Marco Consulting Group - that have voluntarily registered with 

the Commission as investment advisers. 

B. Proposals Contained in the 2010 SEC Concept 

Release 

On July 14,2010, the Securities and Exchange Commission 

voted unanimously to issue a concept release on various aspects of 

the U.S. proxy voting system, opening its first comprehensive 

review of the proxy system in nearly 30 years. "The proxy is often 

the principal means for shareholders and public companies to 

communicate with one another, and for shareholders to weigh in 

on issues of importance to the corporation," said SEC Chairman 

Mary L. Schapiro in announcing the release. "To result in effective 

governance, the transmission of this communication between 

investors and public companies must be - and must be perceived to 

be - timely, accurate, unbiased, and fair,,,l'. Schapiro said. 

Regarding proxy advisors, Schapiro noted that both companies 

and investors "have raised concerns that proxy advisory firms may 

be subject to conflicts of interest or may fail to conduct adequate 

research and base recommendations on erroneous or incomplete 

facts."l85 Twenty-two pages of the J 51-page concept release were 

devoted to a discussion of proxy advisors and potential regulatory 

remedies for conflicts of interest, lack of transparency and 

inaccuracies in proxy analyses and recommendations. 

©2011 Center On Executive Compensation 68 
124 


81762.087

A Call for Change in the Proxy Advisory Industry Status Quo 

With respect to conflicts of interest, the SEC release suggests 

that one possible solution could be for the SEC to revise or provide 

interpretive guidance regarding the proxy rule exemption in 

Exchange Act Rule 14a-2(b )(3), under which a firm providing 

proxy advice must disclose to its clients "any significant 

relationship" it has with the issuer, its affiliates or a shareholder 

proponent. At present, some proxy advisors, including ISS, utilize 

a blanket disclosure in their reports to alert investors that they may 

have done business with the corporation that is the subject of the 

report and direct readers to an email address where they can ask for 

more information. 

Alternatively, the SEC concept release suggests that the 

Commission could take three other approaches to addressing 

contlicts of interest at proxy advisors: 

establish additional rules making it likely that proxy advisors 

would be required to register as investment advisers; 

provide additional guidance on the fiduciary duty of proxy 

advisors or issue rules requiring specific disclosures of 

conflicts by registered investment advisors; or 

issue regulations similar to those addressing conflicts by the 

credit ratings agencies, such as the prohibition of certain 

conflicts of interest and requiring specific disclosures and 

procedures to manage others. 

The release also discusses several proposals for addressing 

concerns about the accuracy and transparency of data and vote 

recommendations by proxy advisors, including: 

requiring increased disclosure of the extent of research 

involved and the procedures and methods used to determine 

ratings or recommendations; 

requiring disclosure of policies and procedures for interacting 

with issuers, informing issuers of vote recommendations and 

handling appeals of recommendations; and 

requiring proxy advisors to publicly file vote recommendations 

with the Commission on a delayed basis. 

The comments received from the concept release will be used 

to determine whether the SEC will pursue add itional regulation of 

proxy advisory services and form the basis for proposed rules on 

the subject. 

©2011 Center On Executive Compensation 69 
125 


81762.088

A Call for Change in the Proxy Advisory Industry Status Quo 

C. Other Regulatory Proposals 

Several variations of the ideas contained in the SEC concept 

release related to regulation of proxy advisors, as well as other 

novel regulatory ideas, have been circulated in recent years, The 

most prominent of these proposals are discussed below, including 

adoption of the credit ratings agency regulatory model, creation of 

public oversight board, development of a unique regulatory 

framework for the industry, and self~regulation through a voluntary 

code of conduct. 

Adoption of Credit Ratings Agency Regulatory Model. As 

discussed in Chapter IV of this paper, there are a number of 

parallels between the conflicts of interest and business model 

issues associated with the credit ratings agencies and those 

associated with proxy advisory firms. Perhaps the most widely 

discussed model for enhancing regulation of the proxy advisors 

involves imposing a regulatory regime similar to that which 

Congress and the SEC havc mandated for credit ratings agencies. 

The SEC received initial authority to regulate credit ratings 

agencies under the Credit Rating Agency Reform Act of 2006, and 

formally votcd in June 2008 to propose a series of reforms for 

credit ratings agencies. Many of these proposals were codified in 

20 I 0 under the Dodd-Frank Act, which imposes substantial new 

controls and transparency requirements on credit ratings agencies. 

Table 4 below lists a number of the new provisions of the DoddFrank Act that apply to credit ratings agencies along with an 

analogous potcntial regulation that could be applied to the proxy 

advisory firms. 

The Dodd-Frank Act also created a new office at the SEC 

charged with overseeing standards related to credit ratings agencies 

and with conducting inspections. It also gave the SEC the 

authority to suspend or revoke the registration of credit ratings 

agencies for failure to satisfy certain requirements. In addition, 

Dodd-Frank required the SEC and the Comptroller General to 

undertake various studies of the credit rating agcncies and their 

processes. Finally, the Dodd-Frank Act rescinded an exemption 

from the Securities Act that shielded credit ratings agencies from 

legal liability related to the inclusion of credit ratings in public 

security registration statements and confirmed the ability of 

investors to seek civil actions against credit ratings firms under the 

Exchange Act. 

Creation of a Public Oversight Board. Another regulatory 

approach that has been suggested for the proxy advisory industry is 

the creation of a federal oversight board similar to the Public 

Company Accounting Oversight Board (PCAOB), which was 

©2011 Center On Executive Compensation 70 
126 


81762.089

A Call for Change in the Proxy Advisory Industry Status Quo 

created in the wake of the Enron and W orldCom accounting 

scandals to oversee the public auditing firms. Professor Tamara 

Belinfanti of New York Law School argues in a 2009 paper that 

such a board could be "designed to provide systematic 

accountability of proxy advisors.,,186 The general features and 

mandate of the PCAOB could be replicated for the proxy advisors, 

including auditing and ethics standards, inspections, registration 

requirements and the ability to invcstigate and discipline registered 

firms, according to Belinfanti. She adds that: 

The sentiments underlying the creation of the PCAOB are similar in contour and substance to the sentiments 

expressed by those concerned about the current 

landscape in the rroxy advisory and corporate 

governance industry. -ike auditors, ISS and other proxy 

advisors hold positions of significant perceived 

authority and expertise on which the market relies. And 

like auditors in the wake of Enron and WorldCom, 

there is a growing sentiment that an unrestrained and un~c.countable prqgy advisory industry is a disaster 

waltmg to happen. 

The parallels to prior meltdowns and the impact of the PCAOB 

make this option worth considering. 

TABLE 4: 

Regulatory Requirement for Credit Similar Potential Regulatory 

Ratings Agencies in Dodd-Frank Act Requirement for Proxy Advisors 

· establish internal controls for monitoring · same 

adherence to established policies and 

procedures 

· submit annual compliance reports to the · same 

SEC 

· take actions to prevent sales and · take actions to prevent sales and 

marketing considerations from affecting marketing considerations from affecting 

ratings voting recommendations 

· set qualifications standards for credit • set qualification standards for proxy 

analysts analysts 

· establish procedures for assessing · same 

possible conflicts of interest with former 

employees 

· maintain an independent board or board · maintain an independent board or board 

committee tasked with certain committee tasked with certain 

responsibilities related to the credit responsibilities related to the proxy 

ratings agency business advisory business 

· publicly disclose ratings methodologies · publicly disclose vote methodologies 

and a description of the underlying data and description of underlying data used 

used in the ratings process in deriving vote recommendations 

· periodically disclose information on the · periodically disclose information on the 

historical accuracy of credit ratings accuracy of vote recommendations 

©2011 Center On Executive Compensation 71 
127 


81762.090

A Call for Change in the Proxy Advisory Industry Status Quo 

Development of a Unique Regulatory Framework for Proxy 

Advisors. Rather than adopting a regulatory framework designed 

for other industries, some observers have proposed that the SEC 

develop a unique regulatory scheme designed specifically for 

proxy advisors. "At a minimum, all proxy advisory firms should 

be required to register as investment advisers, and the SEC should 

develop a unique regulatory framework for these firms under the 

Investment Advisers Act of J 940," states a paper fubJished in 

March 2010 by two prominent business groupS.18 The paper also 

recommends: 

public disclosure of the governance models used by proxy 

advisory firms, including guidelines, standards, methodologies 

and assumptions used in developing voting recommendations; 

establishment of a more robust due diligence process and 

greater disclosure for institutional investors regarding proxy 

voting; 

public disclosure by proxy advisors of all vote 

recommendations and decisions; 

opportunities for public company input on draft proxy reports 

and recommendations; and 

public disclosure by proxy advisors of all errors made in 

executing or processing voting instructions. 

In public comments to the SEC conccpt release filed on Aug. 

5, 20 I 0, the Center for Capital Markets Competitiveness (CCMC) 

of the U.S. Chamber of Commerce makes a number of similar 

recommendations regarding transparency and disclosure and 

proposes that the SEC consider new rules governing proxy 

advisors designed to ensure that "proxy advisors do what they say 

they are in business to dO.,,189 The CCMC letter says that the SEC 

should require proxy advisors to have a process "that demonstrates 

due care towards formulating accurate voting recommendations 

when applied in the unique context of each individual 

company.,,190 This could be accomplished through rules "similar 

to the government's use of the Administrative Procedures Act," the 

CCMC says, and this implementation process should be 

transparent. 191 "It should be apparent to the market, including the 

advisor's own clients, when a recommendation proves correct, and 

when it proves incorrect," the Chamber letter adds, noting that 

"one conseq uence of such transparency might be to encourage 

proxy advisors to compcte with each other based on the quality of 

their voting recommendations.',192 

©2011 Center On Executive Compensation 72 
128 


81762.091

A Call for Change in the Proxy Advisory Industry Status Quo 

Greater Self-Regulation Through a Voluntary Code of 

Conduct. Finally, in addition to various proposals for greater 

government regulation of proxy advisors, some parties have 

advanced the idea of greater industry self-regulation through a 

standardized voluntary industry code of conduct. In 2008, the 

Millstein Center for Corporate Governance and Performance at the 

Yale School of Management held a roundtable workshop with 

institutional investors and proxy advisors and undertook 

independent research on the proxy system. This resulted in a 

policy brief that included a draft code of professional practices for 

the proxy advisory industry. "Considering the oft-repeated concerns that proxy advisors can appear opaque or conflicted, and the 

subsequent worry that conflicts of interest may affect the quality of 

voting recommendations, it is surprising that such a code has not 

yet been drafted," the policy brief stated. 193 "The adoption of an 

industry-wide code of conduct could bring more comfort to other 

market parties, including investors, issuers and other stakeholders, 

who would be able to compare the advisors' policies against an 

industry standard.,,194 

The code of professional conduct developed under the auspices 

of the Millstein Institute was modeled after a code developed in 

2004 by the IOSCO for handling conflicts of interest at credit 

ratings agencies. The code covered four principal areas: I) quality 

and integrity of the recommendation process; 2) advisor 

independence and avoidance of conflicts of interest; 3) advisor 

responsibilities to clients and issuers; and 4) disclosure of the code 

of conduct. 

The code contains more than 45 specific recommendations for 

proxy advisory firms within these four broad areas, a number of 

which have been incorporated into some of the regulatory 

proposals under consideration. Some of the proxy advisory firms 

made written responses to the Millstein Center that included 

statements suggesting they would implement at least some of the 

voluntary code of conduct suggestions. 

©2011 Center On Executive Compensation 73 
129 


81762.092

A Call for Change in the Proxy Advisory Industry Status Quo 

D. Potential for Unintended Consequences from 

Enhanced Regulation of Proxy Advisors 

While many industry participants are strongly in favor of 

greater regulation for the proxy advisory industry, some remain 

concerned that such a move could have negative unintended 

eonsequences, including creating increased barriers to entry for 

new firms, further entrenchment of ISS as the dominant presence 

in the industry and giving proxy advisory firms a government "seal 

of approval" that would enhance their power and credibility. 

Many of the regulatory proposals for proxy advisors outlined in 

this section revolve around increased certification, procedural and 

public filing requirements that would likely increase costs for 

proxy advisory firms. The impact of these increased costs would 

likely be most significant, however, for smaller firms in the 

industry and potential new entrants, rather than on the industry 

leaders. With the possible exception of conflicts of interest, the 

problems in the proxy advisory industry "would not be solved, and 

may even be exacerbated, by SEC regulation," says Paul Rose, a 

law professor at Ohio State University, who notes a tendency for 

regulation to stifle, rather than promote, competition: 

SEC regulation of the industry may actually increase the 

market power of the few major corporate governance 

players. As Jonathan Macey has argued in the context of 

derivatives regulation (a much more competitive industry 

than governance ratings, at least in tenns of the number of 

significant market participants), the fixed costs associated 

with regulation would serve as barriers to entry of new 

competitors in the market. This would be an especially 

unfortunate side-effect in a market that is already dominated 

by a single firm which competes with only a handful of 

others. 195 

A February 2010 Center survey of its Subscribers regarding 

regulation of the proxy advisors by a federal agency as a way of 

ensuring quality control by proxy advisors and reinforcing the 

integrity of the proxy voting process, found that nearly two-thirds 

of the respondents favored regulation. But a signifieant minority 

questioned the effectiveness of this approach or raised concerns 

about unintended consequences. One respondent stated a concern 

that regulation would amount to a "Good Housekeeping Seal of 

Approval" for proxy advisors that could give them "undue 

credibility." Another echoed this sentiment, stating that regulation 

"would give [advisors] even more legitimacy than they already 

have and could cause some shareholders to believe that because 

they aTe regulated by the SEC, their opinion should be given 

greater weight."l96 

©2011 Center On Executive Compensation 74 
130 


81762.093

A Call for Change in the Proxy Advisory Industry Status Quo 

E. The Need for Effective Enforcement 

Despite legitimate concerns over the unintended consequences 

of regulation, a regulatory approach may he the most effective 

means to begin to unravel the web of conflicts and the inaccuracies 

in reports produced by the industry. Thus, whatever changes to 

regulation of the proxy advisory industry get made, effective 

enforcement will be a key element in their success. 

To date, the proxy advisory firms that are registered as 

investment advisers have not been subject to significant SEC 

enforcement actions, despitc considerahle concern about conflicts 

of interest, lack of transparency and inaccuracies in their reports.197 

SEC enforcement in the proxy voting field to date has primarily 

focused on warning institutional investors of their duty to take 

reasonable steps to ensure that, when they use third-party proxy 

advisors, these advisors are independent and can make voting 

recommendations that are impartial and in the best interests of the 

investor's clients. In 2009, the SEC settled its first enforcement 

action against an investment adviser for not sufficiently describing 

its proxy voting policies and procedures and for failing to disclose 

a material conflict of interestl98 

At least one observer has suggested that SEC enforcement 

could potentially become more robust if the SEC's Division of 

Corporate Finance took a greater role in regulating proxy advisors 

rather than deferring to the Division of Investment Management, 

which regulates investment advisers. Paul Rose, a law professor at 

Ohio State University, notes in a paper examining the corporate 

governance industry that the SEC's Division of Corporate Finance, 

which oversees corporate disclosure, including proxy statement 

and shareholder proposal reviews, has already issued rules to limit 

auditor and sccurity analyst conllicts of interest. Rose argues that 

it could do so for proxy advisors as well. "It is possible that the 

Division of Corporation Finance would take a different view of 

ISS' potential conflicts than the Division ofinvestment 

Management," Rose writes, and "the Division of Corporation 

Finance is under no obligation to tefrain from regulating the 

corporate governance industry nor from referring a conflicts matter 

to the SEC's Division of Enforcement if it perceives a problem 

with the industry'S aetivities.,,199 This approach would be 

consistent with the SEC's role as the protector of investors and 

with ensuring that information disclosed by corporations is being 

transmitted accurately to institutional investors. 

©2011 Center On Executive Compensation 75 
131 


81762.094

A Call for Change in the Proxy Advisory Industry Status Quo 

IX. Potential for Addressing the 

Market Power of Proxy Advisors 

Through Increased Competition 

An alternative or supplemental approach to increased 

regulation of the proxy advisory industry as the primary 

mechanism for addressing the substantial problems in the industry 

-including conflicts of interest, lack of transparency and 

concentrated market power - is to foster greater competition in the 

industry and expand voter participation, This section will discuss 

the need for greater competition in the industry and two prominent 

ideas for spurring competition and broader voter participation, 

A. The Case for Greater Competition in the Proxy 

Advisory Industry 

A common theme expressed by many who have an interest in 

the proxy voting system is the need for greater competition in the 

proxy advisory business because ofthe level of unchecked power 

of the largest proxy advisors, The relative lack of competition in 

the industry has been commented on in many studies of the 

industry, including the 2007 Government Accountability Office 

report, which noted that ISS had more clients than all of the other 

proxy advisory firms combined?OO The GAO reported that many 

of the institutional investors it had interviewed believed "that 

increased competition could help reduce the cost and increase the 

range of available proxy advisory services,',,01 It also noted, 

however, that significant barriers to new competition existed in the 

industry, including the need to offer comprehensive company 

research coverage and sophisticated database and vote execution 

platforms. Moreover, it stated that "because of its dominance and 

perceived market influence, corporations may feel obligated to be 

more responsive to requests from ISS for information about 

proposals than they might be to other, less-established proxy 

advisory firms, resulting in a greater level of access by ISS to 

corporate information that might not be available to other 

finns.'~201 

A number of academics have also written about the relative 

lack of competition for ISS. Tamara Belinfanti, a professor at New 

York Law School, has postulated that "the anemic level of 

competition" currently present in the proxy advisory industry is 

due to significant "first mover" advantages for ISS as well as 

significant barriers to entry.103 Among the "first mover" 

advantages that accrue to ISS, Belinfanti says, are network effects, 

©2011 Center On Executive Compensation 76 
132 


81762.095

A Call lor Change in the Proxy Advisory Industry Status Quo 

consumer switching costs, acquisition of resources and assets and 

technology preemption. Regarding network effects, she notes that 

"on the institutional client side, the more mutual funds that use 

ISS' services, the more a mutual fund can feel secure in relying on 

ISS' advice because it is assured that its voting practices are in line 

with the industry.,,204 Among the barriers to entry cited by 

Belinfanti are a need to provide company coverage that matches 

that provided by ISS (more than 40,000 companies in 110 

countries); the development, implementation and maintenance of 

sophisticated technology platforms; and the costs for clients of 

switching vote execution services. 

While first mover advantages and barriers to entry have no 

doubt played a role in ISS maintaining a dominant position, as 

discussed in Chapter III, the firm's strategy of habitually buying its 

largest rivals has also been a key factor in its market dominance. 

Proxy Governance Inc., a former ISS competitor, summed up the 

competitive situation regarding ISS in a letter to the Millstein 

Institute and the SEC as follows: "[i]f there is one issue on which 

virtually all market participants (with the possible exception of 

RiskMetricslISS) would seem to agree, it is that there should be 

more than one proxy advisor and that the perpetuation of the nearmonopoly status ofRiskMetrics/ISS is not in the long-term 

interests of investors or our capital markets.,,205 This statement is 

particularly noteworthy as Proxy Governance, Inc. abruptly ceased 

its operations at the end of2010, leaving most institutional 

investors with two options for proxy advisory services: ISS or 

Glass Lewis206 Proxy Governance entered into an agreement with 

ISS' com~etitor, Glass Lewis, to assume all oftheir customer 

contracts. 07 

While the need for greater competition in the proxy advisory 

field is evident, the willingness of investors to support more than a 

few firms in the industry remains very much in question. The 

GAO study acknowledged this dilemma, noting that some of the 

investors it had spoken with "questioned whether the existing 

number affirms is sufficient, while others questioned whether the 

market could sustain the current number offirms.,,208 

In comments to the SEC, a law firm made a similar point 

stating that "[g]iven the costs attendant to establishing a proxy 

adviser and coverage of even the most widely held stocks, we are 

highly skeptical that there will be new market entrants, and we 

believe that as more mutual funds engage proxy advisers to assist 

in developing and implementing proxy voting policies and 

procedures the virtual monopoly enjoyed by the current providers 

in the proxy adviser market will only grow more powerful.,,209 

Meanwhile, the SEC, as part of its review of the U.S. proxy 

©2011 Center On Executive Compensation 77 
133 


81762.096

A Call for Change in the Proxy Advisory Industry Status Quo 

system, has taken note of the dominant market position oflSS 

among proxy advisors and asked for comments on how this may he 

affecting the quality of voting recommendations from ISS and 

other proxy advisors. 210 

B. A Non-Profit Utility Model for Proxy Services 

In addition to the perceived need for more competition in the 

proxy advisory field - and a diminution in the market power of ISS 

some industry participants have articulated the need for a 

different business model for proxy advisors to hetter serve the 

puhlic interest and to remove conflicts of interest associated with 

the fact that all of the major proxy advisors are commercial 

businesses. Specifically, an argument has heen made that the 

interests of investors, issuers and the public would he better served 

with a system where the provision of proxy research and 

recommendations was treated like a public utility function - with 

low prices, heavily regulated procedures and no conflicts - rather 

than as a specialized consulting service. 

As noted in Chapter lIT, one proxy advisor, Proxy Governance 

Inc., had explored the concept of reconstituting itself into a nonprofit entity called the Proxy Governance Institute. In a June 2010 

public letter to the SEC, Proxy Governance said that the 

"underlying premise of this concept is that corporate governance 

and, by extension, proxy voting are matters of public policy with 

important societal implications that transcend anyone company, 

shareholder or group ofshareholders.,,211 The letter stated that the 

new institute would serve "individual and institutional investors, 

issuers and the public interest by providing low-cost - and, in some 

cases, free independent and conflict-free corporate governance 

advice and information." In a concept summary attached to the 

letter, Proxy Governance outlined a number of key points 

regarding its concept and business model for the Institute. 

The letter from Proxy Governance to the SEC about its 

proposal for the Institute also reinforces the notion that the 

competitive landscape in the proxy advisory industry is difficult 

for smaller firms. The letter states that "the business incentives 

for providing ready access to quality corporate governance and 

proxy voting services are substantially narrower than the wideranging need for these services." The letter adds that while its 

"approach to governance, its work product and research and voting 

technology are highly regarded, its influence in addressing these 

challenges has not met expectations.,,212 It is ironic that this 

proponent of increased competition in the proxy advisory industry 

recently succumbed to the realities of a tough economy and an 

industry monopolized by one firm. Having struggled for quite 

©2011 Center On Executive Compensation 78 
134 


81762.097

A Call for Change in the Proxy Advisory Industry Status Quo 

some time, Proxy Governance ceased its operations at the end of 

2010, entering into an agreement with Glass Lewis to take over 

their customers' proxy voting and advisory services contracts.213 

Several other firms have also reccntly entered the proxy 

research or voting information market using a non-profit structure. 

The Sustainable Investments Institute (Si2) supported primarily by 

a group of college and university endowments, provided proxy 

rescarch on social and environmental issues during its first proxy 

season in 20 I O. And several organizations that seek to assist retail 

investors in voting have also chosen a non-profit structure. In some 

ways, the founding of Si2 and the proposed reconstitution of Proxy 

Governance as a non-profit represent a circling back to the origins 

of the proxy advisory industry when the Investor Responsibility 

Research Center operated as a not-for-profit. 

One aspect of the Proxy Governance Institute proposal that 

raised an interesting fiduciary question is the concept of giving 

"open access" to the Institute's voting platform for third parties to 

express their corporate governance views or recommendations. 

By allowing various institutions to display their voting patterns or 

recommendations on its platform, the Institute would make it 

easier for institutional investors to follow the voting advice of 

other like-minded institutions. Or, taking the concept one step 

further, an investor could choose to vote according to the 

consensus pattern of vote recommendations from mUltiple 

institutions (and/or proxy advisors) that the investor selected 

because it believed those institutions had the most thoughtful 

approach to proxy voting. One question that arises from this 

approach is whether an institutional investor that chose to 

essentially follow the voting policies and recommendations of 

another institution (or a group of institutions) would be meeting its 

fiduciary duties with respect to proxy voting. 

Some observers have argued that the fiduciary protection that 

an institutional investor should receive from following the voting 

recommendations of another institutional investor that had taken a 

careful and diligent approach to proxy voting should, if anything, 

be superior to that received from following the advice of a proxy 

advisor - if for no other reason than that the other institution's 

voting would be based on having an actual financial stake in the 

voting outcomes. It is believed that this issue has never been 

litigated and that the SEC has not offered any guidance on it. 

The issue is important, however, because it has the potential to 

diminish the influence of proxy advisory services by allowing 

investors to readily meet their fiduciary obligations for proxy 

voting in a cost-effective manner without hiring a proxy 

advisory finn. 

©2011 Center On Executive Compensation 79 
135 


81762.098

A Call for Change in the Proxy Advisory Industry Status Quo 

c. Mechanisms to Promote Greater Participation in 

Proxy Voting by Retail Investors 

Another potential way to bring greater competition to the proxy 

voting market involves the promotion of higher participation rates 

and better informed voting by retail investors. This issue has 

received increasing attention over the last two years for several 

reasons. First, there has been a noticeable falloff in the already 

low historical level of proxy voting by retail investors in recent 

years due to changes in how issuers are allowed to disseminate 

proxy information. At the same time, however, certain 

technological and infrastructure deVelopments are underway that 

have the potential to greatly facilitate the ability of retail investors 

to utilize what has been termed "client-directed voting." 

Proxy voting by retail investors has historically been at a much 

lower participation rate than that for institutional investors, many 

of which have a fiduciary obligation to vote. A number of 

academics have suggested that this low voting participation is a 

rationale response by retail investors to their limited information 

and impact on voting results. Stephen Bainbridge, a law professor 

at the UCLA School of Law, has noted: 

Given the length and complexity of corporate disclosure 

documents, especially in a proxy contest where the 

shareholder is receiving mUltiple communications from the 

contending parties, the opportunity cost entailed in 

becoming informed before voting is quite high and very 

apparent. In addition, most shareholders' holdings are too 

small to have any significant effect on the vote's outcome. 

Accordingly, shareholders can be expected to assign a 

relatively low value to the expected benefits of careful 

consideration. Shareholders are thus rationally apathetic. 

For the average shareholder, the necessary investment of 

time and effort in making informed voting decisions simply 

is not worthwhile.'" 

According to data provided by Broadridge Financial Services, 

among retail investor accounts in 2009, 17 percent of Objecting 

Beneficial Owner (OBO) accounts voted (representing 34 percent 

of shares held by these accounts) while 15 percent of NonObjecting Beneficial Owner (NOBO) accounts voted (representing 

25 percent of shares held in these accounts.)2!5 This contrasts with 

institutional voting rates that typically exceed 90 percent. The lack 

of voting participation by retail investors (or by brokers on their 

behalf) is important to corporate issuers and to voting results 

because retail investors have traditionally cast their votes 

disproportionately in support of management on shareholder 

voting matters when compared to major institutional investors. 

©2011 Center On Executive Compensation 80 
136 


81762.099

A Call for Change in the Proxy Advisory Industry Status Quo 

The Impact of E-Proxy on Retail Voting Participation. 

Retail voting participation has fallen sharply in recent years at least 

in part due to new regulations adopted by the SEC permitting the 

electronic delivery of proxy materials, including through a "notice 

and access" process that allows issuers to send shareholders only a 

notice describing the availability of proxy materials on the Internet. 

The SEC adopted these "e_proxy" rules in 2007 and they were first 

utilized by a significant number of companies in 2008. By the 

2010 proxy season, more than 1,500 companies were utilizing 

"notice and access" proxy delivery?16 

While the new rules led to large documented savings in proxy 

distribution costs for companies, they also brought a dramatic 

decline in retail investor voting at accounts who received the 

notice-only proxy delivery option. John White, former Director of 

the SEC's Division of Corporate Finance, noted in August 2008 

that during the 2008 proxy season, the 653 issuers who used the 

"notice and access" process experienced a 73 percent drop in the 

number of retail accounts voting and a 52 percent drop in retail 

shares voted.217 

More recent data provided by Broadridge shows that for the 

II-month period from July 1,2008 through May 31, 2009, among 

issuers who used a "mixed-option" method using "notice and 

access" delivery for some retail accounts and "full-set" delivery for 

others - the percentage of retail accounts that voted when receiving 

notice-only was only 4.1 percent, compared with 21.4 percent for 

retail accounts that received "full-set" delivery of proxy 

materials.218 The drop in the actual percentage of retail shares 

voted was less, with 13.5 percent of shares voted by notice-only 

retail investors versus 28.6 percent during the same period by 

"full-set" investors - meaning that the retail investors with the 

largest holdings under either delivery option were more likely to 

vote. 

The SEC has indicated concern about the drop in retail voting 

and, in March 2010, it adopted amendments to its rules regarding 

the Internet availability of proxy materials. The new rules are 

designed to provide additional flexibility to issuers regarding the 

format of shareholder notices and to allow issuers to include 

explanatory materials in shareholder communications under the 

"notice and access" delivery system?19 The Commission also 

expanded its Office of Investor Education and Advocacy and 

greatly expanded the portion of its Investor.gov website dedicated 

to providing information related to proxy voting with an eye 

toward making it easier for retail investors to understand how to 

vote. 

©2011 Center On Executive Compensation 81 
137 


81762.100

A Call for Change in the Proxy Advisory Industry Status Quo 

Initiatives to Promote Client-Directed Voting. At the same 

time that SEC rules for e-proxy were curtailing voting by retail 

investors, other developments were occurring aimed at restoring 

the voting power of retail investors. Perhaps the most prominent of 

these was a campaign to get the SEC to approve and to facilitate 

the development of client-directed voting, or CDV. 

The term "client-directed voting" is generally attributed to 

Stephen P. Norman, Corporate Secretary at American Express 

Company, who proposed it as a way to bolster retail voting 

participation in the wake of the NYSE's 2006 decision to propose 

the elimination of discretionary broker voting in director elections. 

In December 2006, Norman made a presentation advocating CDV 

at a conference. His proposal called for allowing retail investors to 

inform brokers of their predetennined proxy voting instructions, 

which the brokers would then execute in cases where the investor 

did not return a proxy vote. These voting instructions would be set 

at the time of the original agreement between the broker and the 

investor, but the investor would retain the right to change or 

override the pre-determined instruction. Norman's CDV proposal 

would allow, but not require, an investor to provide an instruction 

to their broker to vote in a limited number of ways, including: 

vote in accordance with the board's recommendation; 

vote against the board's recommendation; 

abstain from voting; or 

vote proportionately with the broker's instructed votes from 

other retail investors on the same issue?20 

This concept of CDV was quickly endorsed by the Society of 

Corporate Secretaries & Governance Professionals, who said in a 

comment letter to the NYSE that it would "encourage reengagement of that segment of retail owners who are currently not 

voting, or rarely voting" and "provide privacy for those investors 

who seek it, while ensuring a fair vote, the certainty of a quorum, 

and the satisfactory conclusion of business at annual meetings.,,221 

At the same time, however, critics of the limited set of voting 

options under this version of CDV proposed a more expansive 

view of how it should work. "It is possible to conceive of a much 

more robust model for CDV in which retail investors would have 

access to a variety of meaningful choices for directed voting," 

wrote John Wilcox, Chairman of Sodali and an independent 

consultant on corporate governance to TlAA-CREF. "To be 

meaningful, CDV should provide [beneficial owners 1 an array of 

voting analyses and choices from different types of institutional 

investors and other groups, including public pension funds, 

©2011 Center On Executive Compensation 82 
138 


81762.101

A Call for Change in the Proxy Advisory Industry Status Quo 

environmental and social investors, long tenn centrists such as 

TIAA-CREF, labor unions, advocacy investors, etc.," Wilcox 

said.222 Moreover, in the absence of greater voting options, 

customization and accountability mechanisms, Wilcox said, COV 

could be criticized as a "'dumbing-down' exercise or a thinly 

disguised alternative to broker discretionary voting, which is no 

longer pennitted."m 

Similar objections to a narrow interpretation of COV have been 

voiced by Mark Latham and James McRitchie. Latham, a founder 

ofvotcnnedia.org, has championed the idea that individual 

investors could raise both their voting participation and the quality 

of their decisions by using the Internet to copy the voting decisions 

of institutional investors or professional proxy advisors. He has 

also advocated a system where issuers would be required to make 

funds available to professional proxy advisors, who were chosen 

by shareholders, to make their voting recommendations available 

to all shareholdcrs.224 McRitchie, the publisher of an on-line 

corporate governance website, calls for "open COV systems" that 

would allow shareholders "to informally build individualized 

proxy voting policies, much like fonnal policies maintained by 

institutional investors.,,225 Many third-party voting platfonns or 

"feeds" could be created around specific issues of interest to retail 

investors, who could choose to follow voting advice based on their 

specific policy concerns or their affiliation with various "brands" 

that were consistent with their own values. 

Early on-line versions of affinity-based COV voting tools and 

infonnation that allow investors to piggy-back on the vote 

recommendations and knowledge of others arc already in 

operation. Two examples of these systems are MoxyVote and 

ProxyOemocracy. MoxyVote is a free website that allows 

investors to see upcoming annual meeting ballots and the intended 

votes of a variety of different advocacy and investor groups. The 

site is an affiliate of TFS Capital, a registered investment advisor 

with more than $1 billion in hedge fund and mutual fund assets 

under management.226 ProxyOemocracy is a non-profit, 

foundation-supported organization that provides free on-line tools 

and infonnation that allow investors to see how institutional 

investors that publicize their voting intentions in advance of 

meetings intend to vote. It also provides a ranking system 

designed to track the extent to which mutual fund families support 

activist positions in their proxy voting patterns.227 

©2011 Center On Executive Compensation 83 
139 


81762.102

A Call for Change in the Proxy Advisory Industry Status Quo 

The SEC has indicated that it is studying CDV - which it has 

re-Iabeled "advance voting instructions" - as part of its review of 

the U.S. proxy system. Client-directed voting and similar 

developments aimed at retail investors have the potential to lessen 

the overall influence of proxy advisory firms, both by diluting the 

present disproportionate impact of institutional proxy votes and by 

making it easier for entities to provide voting policies or 

recommendations that could be readily and widely utilized by 

others. At the same time, however, the CDV model, if 

implemented in certain ways, could potentially increase the 

influence of proxy advisors. This could be the case, for instance, if 

the voting recommendations of existing proxy advisory firms 

became the most prominent or widely used voting options for retail 

investors on CDV voting sites. 

©2011 Center On Executive Compensation 84 
140 


81762.103

A Call for Change in the Proxy Advisory Industry Status Quo 

IX. The Center On Executive 

Compensation's Recommendations 

for Reform of the Proxy Advisory 

Industry 

The Center On Executive Compensation believes that the most 

effective approach for mitigating and addressing the issues 

surrounding conflicts of interest, lack of transparency, inaccuracies 

in reporting and lack of competition in the industry will require a 

series of regulatory and market reforms. On the regulatory side, 

the Center recommends the following reforms: 

L Ban on Worst Form of Conflicts. The most serious issue 

facing the proxy advisory finn industry is at the largest proxy 

advisory firm, ISS, which provides consulting services to 

corporate issuers while simultaneously providing 

"independent" analyses to institutional investors on those same 

companies. This approach creates a vicious cycle in which 

companies may feel an obligation to patronize ISS for its 

consulting services in order to obtain favorable proxy voting 

recommendations on their proposals. 

The Center believes that it would be impossible for a proxy 

advisory firm to provide both of these services and still meet 

their fiduciary obligations to the institutional investors. For 

this reason, the SEC should ban proxy advisory firms, or their 

affiliates, from providing advisory services to institutional 

investors, while at the same time providing consulting services 

to corporate issuers on the malters of proxy votes. Until the 

change is effective, the SEC should mandate disclosure of the 

fees paid and services obtained from proxy advisors in the 

proxy statement, similar to the disclosures currently required 

for compensation consultants. 

2. Full Disclosure of Other Conflicts. The SEC should 

mandate disclosures designed to make the financial 

relationships that underpin the most controversial aspects of the 

proxy advisory industry transparent to investors. Specifically, 

the Center recommends that the SEC should require proxy 

advisory firms to disclose, in any report containing voting 

recommendations about a specific issuer, whether the firm has 

received consulting fees from either the issuer, or the 

proponent of a shareholder resolution on the ballot at that 

issuer, in the previous year and the amount of those fees. This 

disclosure should be located where it is easily assessable to any 

©2011 Center On Executive Compensation 85 
141 


81762.104

A Call for Change in the Proxy Advisory Industry Status Quo 

investor who is relying on the recommendation in the report. 

This should be in tabular format to allow ease in identifying 

potential conflicts of interest. 

3. Disclosure of Methodologies Behind Voting 

Recommendations. The SEC should mandate that proxy 

advisory firms disclose the analytic processes. methodologies 

and models utilized to derive their voting recommendations. 

For instance. proxy advisory firms that utilize pay-forperformance compensation models to determine 

recommendations on compensation plans or advisory say on 

pay votes should be required to publicly disclose all inputs. 

formulas, weightings and methodologies used in these models. 

Such disclosure would allow issuers and investors to 

effectively assess the merits and weaknesses of such models 

and to provide feedback to proxy advisory firms on these 

models. 

4. Clarification of Fiduciary Duties of Institutional Investors 

and Plan Sponsors. The SEC should provide additional 

guidance to investment advisers and plan sponsors making it 

clear that their fiduciary obligations to vote proxies in the 

interests of investors require diligent monitoring of the 

conflicts, practices and competence of third-party proxy 

advisors. The mere act of hiring a proxy advisor should not be 

sufficient to allow institutions to meet their fiduciary 

obligations. Moreover, these obligations should be vigorously 

enforced to provide a true incentive for institutions to take 

seriously their role in monitoring and influencing proxy 

advisory firm behaviors and policies. 

5. Implement SEC Monitoring of Proxy Firm 

Recommendations The SEC should implement periodic 

reviews of proxy firm research reports to check for accurately 

and completeness, much the way the SEC currently does for 

company filings. SEC review would be an effective means to 

educate proxy advisors regarding the SEC's expectations 

regarding the proxy firms' exercise of due care in issuing 

reports. It would also help educate the SEC as to the role 

proxy advisory firms play in the proxy process. 

In addition to recommending these regulatory reforms, the 

Center believes that private sector corporations and institutions 

should support measures designed to bring additional competition 

into the proxy advisory industry and to promote greater voting 

participation by retail investors. 

©2011 Center On Executive Compensation 86 
142 


81762.105

A Call for Change in the Proxy Advisory Industry Status Quo 

XI. Endnotes 

1 Tamara C. Belinfanti, The Proxy Advisory and Corporate Governance Industry: The Cose for Increased Oversight 

and Control 14 (N.Y.L. Sch. Legal Studies, Research Paper Series 09/10 No. 18, Spring 2009). 

2 Id. at 12. 

3 Jennifer E. Bethel & Stuart L. Gillan, The Impact a/the Institutional and Regulatory Environment on Shareholder 

Voting, FINANCIAL MANAGEMENT 29, 34 (Winter 2002); Cindy R. Alexander, Mark A. Chen, Duane J. Seppi & Chester S. 

Spratt, The Role of Advisory Services in Proxy Voting (Nat'! Bureau of Ecan. Research, Working Paper No. 15143, 

2009). 

4 Alexander, supra note 3, at 3-4. 

5 Yin Wilczek, Bounty Program to Cramp Corporate Boords: ABA Speakers Discuss Governance Provisions, DAILY 

REPORT FOR EXECUTIVES, Aug. 10, 2010. 

6 Kristen Gribben, Proxy Advisers: Intermediaries Spark Changes in Pay Practices, FINANCIAL TIMES, June 17,2009, 

available at http://www-ftcom. 

7 Jeffrey Gordon, 'Say on Pay': Cautionary Notes on the UK Experience and the Case for Shareholder Opt-In 32S 

(Columbia law & Economics Working Paper No. 336; European Corporate Governance Inst. Working Paper No. 

117/2009, Aug. 2009). 

8 Comment letter from Judy Schub, Managing Director, (lEBA, to Elisabeth M. Murphy, Secretary, Sec. Exch. 

Comm'n 3 (Aug. 13, 2009), available at http://sec.gov/comments/s7-10-09/s71009-123.pdf. 

9 U.S. GOV'T ACCOUNTABILITY OFFICE, CORPORATE SHAREHOLDER MEETINGS: ISSUES RELATING TO FIRMS THAT ADVISE INSTITUTIONAL 

INVESTORS ON PROXY VOTING, GAO-07-76S, 10 (2007). 

10 Meagan ThompsonMMann, Voting Integrity: Practice for Investors and the Global Proxy Advisory Industry 9 (Yale 

Sch, of Mgmt Millstein Ctr, for Corporate Governance & Performance, Policy Briefing No.3, 2009), 

11 Ira M, Millstein, ISS'Role in Corporate Governonce Standords Setting, Speech at the Annual Conference of 

Institutional Shareholder Services (Oct, 19, 200S), 

12 Alistair Barr, Controversy Ignites CompetiUon in Proxy Advisory Business, Dow JONES NEWS SERVICES, June 11, 2007, 

13 HR Policy Ass'n, 2010 Summer Chief Human Resource Officer Survey, Sept, 1, 2010. 

14 BROADRIDGE INVESTORCOMMUN!CATION SOLUTIONS, 2010 PROXY SEASON: KEVSTATlSTICS & PERFORMANCE RATINGS, 2010. 

15 Press Release, Yale Univ. Office of Pub. Affairs, SOM Event Explores the Origins of Shareholder Activism Around 

the World (Oct. 30, 2009). 

16 Stuart l. Gillan & laura T, Starks, The Evolution of Shareholder Activism in the United States, 19 JOURNAL OF ApPLIED 

CORPORATE FINANCE S5 (Winter 2007). 

17 The rule was first designated Rule X~14 A7. See Sec, Exch, Act ReI. No. 3347 (Dec. 18, 1942). This rule is a 

predecessor to current SEC Rule 14a-B, 17 C.F.R. § 240. 

18 Gillan, supra note 16. 

19 THE CONFERENCE BOARD, 2008 INSTITUTIONAL INVESTMENT REPORT: TRENDS IN INSTITUTIONAL INVESTOR ASSETS AND EQUITY 

OWN~RSHIP OF U.s, CORPORATIONS (Sept, 2008). 

20 NACO Directorship, Institutional Ownership Multiplies, Sept. 2, 2008, http://www.directorship.com. 

21 THE CONFERENCE BOARD, supro note 19, 

22 While the S&P SOO Index dates back to 1957, index investing was not readily available until the early 1970s, 

when severa! investment managers - including John McQuown and David Booth at Wells Fargo, Rex Sinquefield at 

American National Bank, and John Bogle, the founder of Vanguard Group -- recognized that most mutua! fund 

managers were not outperforming broad market indices and launched index funds. The concept met with 

skepticism at first, but became increasingly popular as growing numbers of investors accepted an economic theory 

known as the efficient-market hypothesis, which held that all relevant new information about a company's 

prospects was rapidly incorporated into stock prices. By the early 1980s, major indexing firms, such as 

Dimensional Fund Advisors, Batterymarch and the Russell Investments, were launching equity indices or funds 

aimed at large institutional investors. 

23 BROADR1DGE INVESTOR COMMUNICATION SOLUTIONS, supra note 14. 

©2011 Center On Executive Compensation 87 
143 


81762.106

A Call for Change in the Proxy Advisory Industry Status Quo 

24 letter from Allan lebowitz, Deputy Assistant Seely of the Pension Welfare Benefits Admin. at the U.S. Dep't of 

Labor, to Helmuth Fandl, Chairman of the Ret. Bd., Avon Products, Inc. (Feb. 23, 1988). 

25 td.; See also Dep't of labor Interpretive Bulletin 94-2 (July 29, 1994) (In this subsequent interpretive bulletin, the 

Department of Labor reiterated and augmented the Avon letter extending the fiduciary principles regarding proxy 

voting to the shares of foreign corporations). 

26 Sec. Exch. Comm'n, Final Rule: Proxy Voting by Investment Advisers, Advisers Act Release No. lA-2106, 17 C.F.R. 

§ 275 (Jan. 31, 2003). 

27 fd, 

28 1d. 

29 Letter from Douglas Scheidt, Associate Director and Chief Counsel, Sec. Exch. Comm'n, to Kent Hughes, 

Managing Director, Egan-Jones Proxy Services (May 24, 2004). 

30 Charles M. Nathan, The Porollel Universes of Institutional Investing and Institutional Voting, HARVARD LAw SCHOOL 

FORUM ON CORPORATE GOVERNANCE AND FINANCIAL REGULATION, April 6, 2010, 

http://blogs.law.harvard.edu/corpgov/2010/04/06/the-parallel-universes-of-institutional-investing-andinstitutional-voting/; Charles M. Nathan, The Future of Institutional Shore Voting: Three Porodigms, HARVARD LAw 

SCHOOL FORUM ON CORPORATE GOVERNANCE AND FINANCIAL REGULAT!ON, July 23, 2010, 

http://blogs.law.harvard.edu/corpgov/2010/07/23/the-future-of-institutional-share-voting-three-paradigms/. 

31 Charles M. Nathan, The Future of Institutional Shore Voting: Three Porodigms, HARVARD LAw SCHOOL FORUM ON 

CORPORATE GOVERNANCE AND FINANCIAL REGULATION, July 23, 2010, 

http://blogs.law.harvard.edu/corpgov/2010/07/23/the-future-of-institutional-share-voting-three-paradigms/' 

32 Sec. Exch. Comm'n, Compliance Alert, July 2008, http://www.sec.gov/about/offkes/ocie/complialert0708.htm. 

33 Gibson, Dunn & Crutcher, LLP , SEC Enforcement Action Focuses on Investment Adviser's Proxy Voting Policies 

and Procedures (May 21, 2009). 

34 Press Release, Sec. Exch. Comm'n, SEC Votes to Seek Public Comment on U.S. Proxy System (July 14, 2010). 

35 New York Stock Exchange Comm'n on Corp. Governance, Report of the New York Stock Exchange Commission on 

Corporote Governonce, Sept. 23, 2010, at 15 http://www.nyse.com/pdfs/CCGReport.pdf. 

36 Charles M. Nathan, The Porollel Universes of Institutionollnvesting ond Institutional Voting, HARVARD LAw SCHOOL 

FORUM ON CORPORATE GOVERNANCE AND FINANCIAL REGULAnON, April 6, 2010, 

http://blogs.law.harvard.edu/corpgov/2010/04j06/the-parallel-universes-of-institutionaHnvesting-andinstitutional-voting/. 

37 Leo E. Strine Jr., The Delaware Way: How We Do Corporote Lowond Some of the New Challenges We (And 

Europe) Face, 30 Del. J. Corp. L. 673, 688 (2005). 

38 Leo E. Strine Jr., Toward a True Corporate Republic: A Traditional Response to Lucion's Solutions for improving 

Corporate America, Harvard Law School John M. Olin Center for Law, Economics and Business, Discussion Paper 

Series, No. 541, 11 (2006), http://lsr.nellco.orgjharvard_olin/541. 

39 Dean Starkman, A Proxy Adviser's Two Sides: Some Question Work of iSS for Componies it Scrutinizes, WASH, POST, 

Jan. 23, 2006, at Dl. 

40 Wilczek, supra note 5. 

41 Bethel, supra note 3, at 30. 

42 Ernst G, Maug & Kristian Rydqvist, Do Shareholders Vote Strategically? Voting Behavior, Proposal Screening, ond 

Majority Rules (European Corp, Governance Inst., Working Paper No. 31, 2006), 

43 Alexander, supra note 3. 

44 Id. at 26-27. 

45 Id. at 32. 

46 Stephen Choi, Jill Fisch & Marcel Kahan, Director Elections and the Influence of Proxy Advisors 51 (N.Y.U. School 

of law, Law & Econ, Research Paper Series, Working Paper No. 08-22, 2008). 

47 Colin Diamond & Irina Yevmenenko, Who is Overseeing the Praxy Advisors?, 3 BLOOMBERG CORP, L. JOURNAL 606, 

617 (2008). 

48 There are several variations in majority voting policies. Many companies initially adopted a form of majority 

voting that requires directors who do not receive majority support to tender their resignations, but gave the board 

discretion in deciding whether to accept the tendered resignation. Because of growing investor concern that this 

©20i 1 Center On Executive Compensation 88 
144 


81762.107

A Call for Change in the Proxy Advisory Industry Status Quo 

essentially makes director election votes advisory, more companies are now adopting so-called "true" majority 

election standards. For a history of the development of majority voting policies and standards, see Claudia H. Allen, 

Neal, Gerber & Eisenberg, LLP, Study of Majority Voting in Director Elections (Feb. 20, 2006 & Nov. 12, 2007). 

49 Elizabeth Amon, WifJ Majo,;ty Voting Prevail in Corporate Elections, CORPORATE COUNSEL, July 21, 2006, available 

at http://www.law.com/jsP/cc/PubArticleCCjsp ?id=90000545842 8. 

sa Council of Institutional Investors, Majority Voting for Directors, 

http://www.cii.org/resQurcesKeyGovernancels5uesMajorityVotingForDirectors. 

51 RiskMetrics Group, 2010 Postseason Report, at 44. 

52 The percentage of smaller companies who have adopted majority voting is much lower- approximately 25 

percent according to a 2008 study. See Anna!isa Barrett & Beth Young, Majority Voting in Director Elections -It is 

Not Yet Standard Practice, THE CORPORATE llBRARY (Dec. 2008). 

53 For example, during 2007 and 2008, of the fifteen companies where precatory proposals asking companies to 

implement annual say on pay vote received majority support, only five of those companies implemented such a 

vote. See Press Release, The Corp. Library, Two-thirds of Companies Ignore Majority Support of 'Say on Pay' (July 

22,2008). However, the percentage of firms that implemented say on pay votes after having majority-supported 

precatory proposals on this issue in 2009 and 2010 has risen. Jd. 

54 Troubled Assets Relief Program, Pub. L No. 110-343, 122 Stat. 3765 (2008). 

55 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L No. 111-203, 124 Stat. 1376 (2010). 

S6 Center On Executive Compensation data. 

57 Press Release, Towers Watson, Few U.S. Companies Well Prepared for Executive Say on Pay legislation, Towers 

Watson Survey Finds (June 29, 2010), htlp://www.towerswatson.com/united-states/press/2373. 

58 Gribben, supra note 6. 

59 Mary Hughes, Heightened SEC Expectations for Disclosure May Require Amended Filings, Official Says, DAllY 

REPORT FOR EXECUTIVES, June 3, 2010. 

GO Peter C. Clapman, Next Steps? Be Careful What You Wish For, DIRECTORS & BOARDS, Summer 2008, 

http://www.entrepreneur.com/tradejournals/article/181776560.htm!. 

61 Sec. Exch. Comm'n, Self-Regulatory Organizations: New York Stock Exchange LlC; Order Approving Proposed 

Rule Change, as modified by Amendment No.4, to Amend NYSE Rule 4S2 and Corresponding Listed Company 

Manual Section 402.08 to Eliminate Broker Discretionary Voting for the Election of Directors, Except for Companies 

Registered under the Investment Company Act of 1940, and to Codify Two Previously Published Interpretations 

that Do Not Permit Broker Discretionary Voting for Material Amendments to Investment Advisory Contracts with 

an Investment Company; Release Nos. 34-60215; File No. SR-NYSE-2006-92 (July 1, 2009). 

62 See Scott Fenn, Sharp Increase in Shareholder Votes Opposing Director Nominees, HARVARD LAw SCHOOl FORUM ON 

CORPORATE GOVERNANCE AND FINANCIAL REGULATION, Sept. 29, 2009, 

http://blogs.law . ha rva rd.edu/ corpgov /2009/09 /29/sharp-increase-in-sh a reholder -votes-opposing-directornominees/. 

63 Skadden, Arps, Slate, Meagher & Flom, LLP & Affiliates, The Dodd-Frank Act: Commentary and Insights 93 (July 

12,2010). 

&4 Press Release, Sec. Exch. Comm'n, SEC Adopts New Measures to Facilitate Director Nominations by Shareho!ders 

(Aug. 25, 2010). 

65 Sec. Exch. Comm'n, Final Rule: Facilitating Shareholder Director Nominations, Release Nos. 33-9136; 34-62764; 

IC-29384; File No. 57-10-09, 17 CF.R. §§ 200, 232,240,249 (Aug. 25, 2010). 

66 Sec. Exch. Comm'n, Final Rule: Shareholder Proposa!s Relating to the Election of Directors, Release No.34-S6914; 

File No. 57-17-07, 17CF.R § 240 (Jan. 10, 2008). 

67 See Bus. Roundtable & Chamber of Commerce of the U.S. v. Sec. Exch. Comm'n, Case No. 10-130S (D.C. Cir. Sept. 

29,2010) {seeking review of recent changes to SEes proxy and related rules and to stay effect of new rules 

pending review}. 

68 Comment letter from Judy Schub, supra note 8, at 3. 

69 RiskMetrics Group, inc., Registration Statement (Form S-l)(Sept. 19, 2007). In connection with its IPO, the 

consideration paid to ISS included $482.7 million in cash, 2,774,3S1 shares of RiskMetrics common stock with a 

©2011 Center On Executive Compensation 89 
145 


81762.108

A Call for Change in the Proxy Advisory Industry Status Quo 

value of $42.4 million, and 1,396,000 stock options valued at $16.3 million. The document also notes that 

RiskMetrics borrowed $425 million to complete the acquisition. 

7D MSCllnc., Quarterly Report (Form 10-Q) (July 2,2010). 

71 Institutional Shareholder Services, Inc., Uniform Application (Form ADV) (Mar. 31, 2010). Form ADV is an annual 

SEC filing made by registered investment advisers. 

72 ISS for Sale, GLOBAL PROXY WATCH (Davis Global Advisors Inc.), Sept. 8, 2006. 

73 Aaron Lucchetti, MSCI Seizes RiskMetrics in Union of Niche Firms, WALL ST. J., March 2, 2010. 

7~ John Greenwald, What's Nextfar Caesar's Wife?, CORPORATE BOARD MEMBER, 2 nd Quarter 2010. 

" RiskMetrics Group, Annual Report (Form 10-K) (Feb. 24, 2010). 

76 Jd. 

77 ld. 

78 Jd. 

79 Institutional Shareholder Services, Inc., Due Diligence Compliance Package 7 (Mar. 2010), available at 

http://www.issgovernance.com/files/ISSDueDiligenceComplfancePackage.pdf. 

so RiskMetrics Group, supra note 75, at 17. 

:<31 See~ e.g., Robert Daines, Ian Gow & David Larcker, Rating the Ratings: How Good are Commercial Corporate 

Governance Ratings? (Stanford Univ. Sch. of Law, Law & Econ. Research Paper Series, Paper No. 360, Sept. 4, 

2009). 

82. Glass Lewis was initially registered as an investment adviser but it withdrew that registration in 2005. See U.S. 

GOv'T ACCOUNTABILITY OFFICE, supro note 9, at 9. 

13"3 Gretchen Morgenson, How to Succeed on Wall Street, Conflict-Free, N.Y. TIMES, Dec. 19, 2004. 

B4 Glass, Lewis and Co, - Rustic Canyon, http://www.rusticcanyon.com(describingthe capitalization of Glass, Lewis 

& Co.). 

85 Glass, lewis & Co., Notice of Exempt Offering of Securities (Form D) Sept. 28, 2005. 

86 Xinhua Finance, 2008 Annual Report. 

87 Press Release, Glass, Lewis & Co., Xinhua Finance to Acquire Glass, Lewis & Co.(Dec. 14, 2006), avaifable at 

http://www.glasslewis.com/down loads/62 4-62.pdf. 

88 Sarah Coffey, Glass Lewis Execs Quit Amid Disclosure Concerns, REUTERS (May 21, 2007). 

89 David Scheer, Glass Lewis Director Resigns, Citing Firm's Takeover, BLOOMBERG (May 21, 2007). 

90 Canada Pension Fund to buy Proxy Advisor Glass Lew,s, REUTERS (Oct. 5, 2007). 

91 Glass, Lewis & Co., What We Do, httpJjwww.glasslewis.com/solutions/index.php. 

92. Press Release, Glass, Lewis & Co., Leading governance firm to provide PGI clients with proxy voting and advisory 

services (Dec. 20, 2010) (explaining there will be a "seamless transfer of customer contracts to Glass Lewis" and 

"PGI will not be providing proxy voting or advisory services after the end of (2010]."), available at 

http://www.prnewswire.com/news-releases/glass-lewis-announces~agreement-with-pgi~112178089.htm!. 

93 Proxy Governance, Inc'l Proxy Governance History, 

www.proxygovernance.com/content/pgi/contentjhistory.shtml. 

94 Proxy Governance, Inc., Uniform Application (Form ADV) (March 19, 2010). 

95 1d• 

96 Proxy Governance Inc., A Better Kind of Proxy Advi50ry and Voting Service, 

https:/ /www.proxygovernance.com/content/ pgijindex.jsp. 97,d. 

98 Proxy Governance, Inc., A Fuli Range of Proxy Advisory, Voting and Reporting Services, 

https://www.proxygovernance.com/content/pgiJcontent/full_range,shtml. 

99 Proxy Governance, Inc., supra note 93. 

100 Proxy Governance, inc., The Proxy Governance Institute: Concept Summary, June 16, 2010; see also 

Barry Burr, Proxy Governance Mulls Change to Nat~for~Profit, PENSIONS & INVESTMENTS, July 22, 2010. 

101 Proxy Governance, Inc., supra note 100, at L 

l02 ld. 

103 1d. at 2. 

l04 ,d. 

©2011 Center On Executive Compensation 90 
146 


81762.109

A Call for Change in the Proxy Advisory Industry Status Quo 

105 Aaron luchetti, Tiny Firm Gives Ratings Giants Another Worry, WALL Sr. J., Feb. 9, 2008, at B1. 

106 Sec, Exch, Comm'n, Order Granting Registration of Egan-Jones Rating Company to Add Two Additional Classes 

01 Credit Ratings, Release No. 59056 (Dec. 4. 2008). 

107 Sean J. Egan, Testimony Before the Senate Committee on Banking, Housing and Urban Affairs (Feb. 8, 2005), 

available at http://banki ng.sena te .gov / pu blic/index.cfm ?FuseAction= Files. View &Fil eStore _id=66c80ccf -ef70~40aO815d-909b39fac24a. 

lOB Egan-Jones Proxy Services, About Egan-lones Proxy, www.ejproxy.com/about.aspx. 109 1d. 

l1O ,d. 

111 Marco Consulting Group, Uniform Application (Form ADV) (jan. 15,2010). 

112 Marco Consulting Group, Prexy Voting, www.marcoconsulting.com/23.html. 

l13 ld.; Marco Consulting Group, Company History, www.marcoconsulting.com/Company_history.htmL 

114 Sustainable Investments Institute, Mission, www.siinstitute.org/index.html. 

115 Leslie Wayne, Have Shareholder Activists Lost Their Edge?, N.Y. TIMES, Jan. 30, 1994, at C7. 

116 Sec. Exch. Comm'n, Concept Release on the u.s. Proxy System, Release No. 34-62495 (July 14, 2010). 

117 U.S. Gov'r ACCOUNTABILITY OfFICE, supra note 9, at 10. 

118 Thompson-Mann, supra note 10, at 9. 

119 Millstein, supra note 11. 

120 Starkman, supra note 39. 

lll/d.; Edward F. Smith, NACO Directorship, White Knight Swoops in for Glass Lewis, Dec. 1,2007, 

http://www.directorship.com/white-knight-swoops-in-for-glass-lewis/. 

122 Institutional Shareholder Services, Inc., supra note 79, at 4. 1(5 is an acronym for ISS Corporate Services, Inc., a 

wholly-owned subsidiary of ISS that provides corporate consulting services. 

123 ,d. at5. 

124 Jd. 

125 1d. {containing both documents}. 

126 RiskMetrics Group, Inc., Annual Report (Form lO-K) (Feb. 24, 2010). 

127 See Institutional Shareholder Services, Inc., Engaging with ISS, 

http://www.riskmetrics.com/policy/EngagingWithISS. On this website, ISS lists the following question and answer: 

My company has purchased services from ISS Corporate Services C'!CS"}. May! note that fact during our 

engagement with the ISS research analysts? 

No. Issuers who are ICS clients may not disclose publicly or to an ISS analyst that they have acquired 

products or services from ICS, per their contract with 1(5. ISS does not give preferential treatment to, and is 

under no obligation to support, any proxy proposal of an issuer whether or not that issuer has purchased 

products or services from ICS. We request that in any communication you may have with ISS analysts, you 

do not disclose your identity as an 1(5 client or potential client, in order to protect the integrity of our 

research process. 

128 Barr, supra note 12. 129 1d. 

130 Ontario Teachers' Pension Plan, Governance, 

http://www.otpp.com/wps/wcm/ conn ect/otp p _ en/Home/Gove rn ance. 

131 Canadian CoaHtion for Good Governance, Welcome to the Canadian CoaNtion for Goad Governance, 

http://www.ccgg.ca. 

132 Institute of Corporate Directors, Mission and Vision, 

http://www .icd .cal AM(T em platel cfm ?Section~ Mlssio n_ and_Vision & T e mplate=/CM/HTM LDisplay.clm &Contentl D 

=62. 

133 Ontario Teachers' Pension Plan, Relationship Investing, 

http://www.otpp.com/wps/wcm/connect/otpp_en/home/investments/public+equities/relationship+investing. 

134 Glass, Lewis & Co., Conflict of Interest Statement, http://www.g!ass!ewis.com/company/disclosure.php. 

©2011 Center On Executive Compensation 91 
147 


81762.110

A Call for Change in the Proxy Advisory Industry Status Quo 

13S Id. 

136 Id. 

137 William J. Holstein, The Ownership of Glass Lewis is All Wrong, BNET Insight, Oct. 29, 2007, available at 

http://www.bnet.com/blog/ ceo!the-ownership-of-glass-Iewis-is-a II-wrong/1048. 

13S See Press Release, supra note 92. 

139 Gretchen Morgenson, Pfizer and the Proxy Adviser, N.Y.TIMES, April 21, 2006. 

140 U.S. GOV'T ACCOUNTABILITY OFFICE, supra note 9, at 12. 

141 Proxy Governance, supra note 93. 

142 See, e.g., Tom Brown, Egan-Janes 15 Conflict-Free? Not a Chance, SEEKING ALPHA, Feb. 12,2008. 

143 Egan-Jones Ratings Company, AppUcation For Registration as a Nationolly Recognized Statistical Rating 

Organization Exhibit 6 (Form NRSRO)(Mar. 28, 2008). 144 1d. 

145 Egan-Jones Proxy Services, supra note 108. 

146 Egan-Jones Ratings Company, Credit Rotings Services7 http://www.egan-jones.com. 

147 Thompson-Mann, supra note 10, at 10. 

148 Marco Consulting Group, supra note 112, 

149 Marco Consulting Group, supra note 111. 

150 Dodd-Frank Wall Street Reform and Consumer Protection Act § 931, Pub.l.111-203, 124 Stat. 1376 (2010). 

151 Sec, Exch. Comm'n, supra note 116~ at 121, 

152 GARY SHORTER & MICHAEL V, SEITZINGER, CONG, RESEARCH SERV., CREDIT RATING AGENCIES AND THEIR REGULATION 6-8 (Sept. 

3,2009). 

153 1d, 

154 Based on the Center On Executive Compensation's analysis of 2009 proxy statements for the top SO companies 

in the Fortune 500. 

155 Thompson-Mann, supra note 10, at 15, 

156 MSCllnc., Current Report (Form 8-K) (July 29,2010). 

157 HR Policy Ass7n, supra note 13, 

15S/d. 

159 Center On Executive Compensation, Results of Quick Survey on Executive Compensation Practices and Policy 

Changes 1-2 Feb. 2010. 

160 Target Corp" White Paper on the RiskMetrics Report on Target Corporation, Proxy Statement (Schedule 14A) 

(May 21, 2009). 

161 Investment Advisers Act of 1940, § 202(a)(11), 15 U.s.c. § 80b-2(a)(1l). 

162 Sec. Exch. Comm'n, supra note 116, at 110. 

163 1d. 

16< See Sec. Exch. Comm'n vs. Capital Gains Research Bureau Inc., 375 U.s. 180 (1963). 

16:' Sec. Exch. Comm'n, supra note 116, at 119. 

166 National Securities Markets Improvements Act of 1996, Pub, L. 104-290, 110 Stat. 3416 (1996). 

'" Investment Advisers Act of 1940 § 203A-2, 15 U.S.c. § 80b-3a(a). 

168 Despite being registered, Proxy Governance ceased providing proxy voting and advisory services at the end of 

2010. Accordingly, only two proxy advisory firms remain that are registered as investment advisers with the SEC 

Proxy Governance entered into an agreement with Glass lewis to assume their customer contracts. Glass Lewis is 

not a registered with the SEC. See Press Release, supro note 92. 

169 Investment Advisers Act of 1940 § 206-2, 15 U.s.c. § 80b-6(2). 

170 U.S. GOV'T ACCOUNTABILITY OFFICE, supra note 9, at 12. 

171 ld. 

1n/d. 

173 Gibson, Dunn & Crutcher, LLP, supra note 33. 

174 1d. 

175 Sec. Ex-ch. Comm'n, supra note 116, at 108-09. 

176 Jd. at 110, 

©2011 Center On Executive Compensation 92 
148 


81762.111

A Call for Change in the Proxy Advisory Industry Status Quo 

177 Strine, Jr., supra note 38, at 11. 

178 Belinfanti, supra note 1, at 40. 

179 Dep't of labor, Definition of the Term "Fiduciary," 75 Fed. Reg. 65,263 (proposed Oct. 22, 2010) (to be codified 

at 29 CF.R. § 2510). 

'so Proposed 29 C.F.R. § 2510.3-21(c)(1)(ii)(C). 

181 Dep't of Labor, supra note 179, at 65,266. 

182 The Department of Labor has requested comments from interested parties regarding the proposed regulations. 

The due date for comments is January 20,2011. The regulations will not become effective until 180 days after the 

publication of the final regulation in the Federal Register. 

183 Press Release, The Int'I Org. of Sec. Comm'ns, Global Securities Regulators Adopt New Principles and Increase 

Focus on Systemic Risk 9 (June 10,2010). 

184 Press Release, supra note 34. 185 1d. 

186 Belinfanti, supra note 1, at 54. 

'" Jd. at 53-54. 

188 Nat'llnvestor Relations Inst. and Soe/y of Corporate Sec'ys & Governance Profls, Proxy Advisory Services: The 

Need for More Regulatory Oversight and Transparency (Discussion Draft, Mar. 4, 2010). 

189 Comment letter from Tom Quaadman, Executive Dir. Fin. Reporting & Iny. Opportunity, (tr. for Capita! Markets 

Competitiveness, to Mary Schapiro, See'y, Sec. Exch. Comm'n 3 (Aug. 5, 2010). 

190Jd. at4. 

19I/d. 

192 'd. 

193 Thompson~Mann. supra note 10, at 18. 194 ,d. 

195 Paul Rose, The Corporate Governance Industry, J. CORP. L 138 (Summer 2007) (dtation omitted). 

196 Center On Executive Compensation, supra note 159, at 4. 

197 U.S. Gov'r ACCOUNTAB!UTY OFFICE, supra note 9, at 12. 

198 See Gibson, Dunn & Crutcher, LlP, supra note 33. 

199 Rose, supra note 195, at 13. 

200 U.S, GOV'T ACCOUNTABILITY OFFICE, supra note 9, at B. 

20i/d. at 15. 

202 1d, at 13. 

203 Belinfanti, supra note 1, at 28, 

204 1d. at 30. 

205 letter from Michael Ryan, Jr., President & Chief Operating Officer, Proxy Governance, to Meagan ThompsonMann, Millstein Inst. for Corporate Governance & Performance 7 (July 23, 2008), available at 

~o~tps:llwww.proxygovernance.com/contentfpgi/img/2008MiJ!steinResponse,pdf. 

Press Release, supra note 92, 207 1d. 

108 U.S. Gov'T ACCOUNTABllI1Y OFFICE, supra note 9, at 14-15, 

209 Comment letter from Troutman Sanders, llP, to jonathan G. Katz, Sec'y, Sec. Exch. Comm'n (Nov. 22, 2002). 

210 Sec. Exch. Comm'n, supra note 116, at 124. 

211 Comment letter from Michael Ryan, Jr., President & Chief Operating Officer, Proxy Governance, to Elisabeth M. 

Murphy, Fed. Advisory Comm. Mgmt. Officer, Sec. Exch. Comm'n (June 25, 2010). 

212 jd. 

213 Press Release, supra note 92. 

214 Stephen M. Bainbridge, Remarks on Sayan Pay: An Unjustified Incursion on Director Authority 10 (UCLA Sch.L., 

law & Economics Research Paper Series, Research Paper No. 08-06, March 4, 2008). 

215 Sec. Indus. and Fin. Markets Ass'n, Report on the Shareholder Communications Pracess with Street Name 

Holders, and the NOBD-DBO Mechanism 20 (Sec. Indus. & Fin. Markets Ass'n. Proxy Working Group, June 10, 

2010). 

©2011 Center On Executive Compensation 93 
149 


81762.112

A Call for Change in the Proxy Advisory Industry Status Quo 

216 BROADRIDGE INVESTOR COMMUNICATION SOlUTIONS, supra note 14. 

217 john W. White, OiL, Division of Corp. Fin., Sec. Exch. Comm'n, Address before the Amer. Bar. Ass'n, Corporate 

Finance - A Year of Progress, (Aug. 11, 2008). 

218 Sec. Exch. Comm'n, Amendments to Rules Requiring Internet Availability of Proxy Materials, Release Nos. 33-

9073; 34-60825, at 7 (Oct. 14, 2009). 

219 Sec. Exch. Comm'n, Final Rule: Amendments to Rules Requiring Internet Availability of Proxy Materials, 

Exchange Act Release Nos. 33-9108, 34-61560, 17 C.F.R. §§ 230, 240 (Mar. 29, 2010). 

220 NYSE Proxy Working Group, August 27,2007 Addendum to Report and Recommendation afthe Proxy Working 

Group to the New York Stack Exchange Dated June 5, 20065 (Aug. 27, 2007). 

221 Comment letter from David W. Smith, Soe'y of Corporate Sec'ys & Governance Prof!s to Catherine Kinney, 

President and Co~Chief Operating Officer, New York Stock Exchange Group (Dec. 14, 2006). 

212 john Wilcox, Fixing the Problems with Client Directed Voting, HARVARD LAw SCHOOL FORUM ON CORPORATE 

GOVERNANCE AND FINANCIAL REGULATION, March 5, 2010, http://blags.law.halVard.edu/corpgav/201O/03/05/iixing-theproblems-with~C!ient-directed-voting/. 

213 ,d. 

22.~ See Mark latham, The Internet Wilt Drive Corporate Monitoring~ CORPORATE GOVERNANCE INT'L (June 2000); Mark 

Latham, Proxy Voting Brand Competition, 5 J. INV. MGMT. 79-90 (2007). 

225 Comment letter from James McRitchie, Publisher, Corporate Governance Int'l, to Elisabeth M. Murphy, Sec'y, 

Sec. Exch. Camm'n (July 16, 2010). 

226 See Moxy Vote, http://www.moxyvote.com. 

227 See Proxy Democracy, http://www.proxydemocracy,org. 

©2011 Center On Executive Compensation 94 
150 


81762.113

Statement of Niels Holch 

Executive Director 

Sharcholder Communications Coalition 

Before the Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Serviccs 

U.S. House of Representatives 

Hearing on "Examining the Market Power and Impact of Proxy Advisory Firms" 

June 5,2013 

Chairnlan Garrett, Ranking Member Maloney, and Members of the 

Subcommittee, my name is Niels Holch, and I am the Executive Director of the 

Shareholder Communications Coalition. 

The Shareholder Communications Coalition (www.shareholdercoalition.com) 

comprises three professional associations representing the interests of public companies: 

Business Roundtable, the Society of Corporate Secretaries & Governance Professionals, 

and the National Investor Relations Institute. 

The Shareholder Communications Coalition was established in 2005, after 

Business Roundtable filed a Petition for Rulemaking with the Securities and Exchange 

Commission ("SEC") in 2004, urging the agency to conduct a comprehensive evaluation 

ofthe shareholder communications and proxy voting system. 

Many of the current SEC rules govcrning this system were adopted in 1985, more 

than 25 years ago. These SEC rules were promulgated during a period when most annual 

meetings were routine, and few matters were contested. These rules also were developed 

at a time when technology and electronic communications were not nearly as 

sophisticated as they are today. 
151 


81762.114

It was not until six (6) years after the Business Roundtable Petition for 

Rulemaking was filed that the SEC undertook an evaluation of the shareholder 

communications and proxy voting system, and, in July 2010, released for public 

comment a Concept Release on the U.S. Proxy System. 

In its Concept Release, the SEC acknowledged that the time had come to review 

various aspects of the U.S. proxy system. The Concept Release outlined concerns that 

have been raised regarding the accuracy, reliability, transparency, accountability, and 

integrity of the current proxy system. The Concept Release also discussed possible 

regulatory solutions to the many problems that have been identified, including those 

related to shareholder communications, proxy distribution and voting, and proxy advisory 

services. 

The SEC received more than 300 comment letters in response to this Concept 

Release, the substantial majority of which expressed the view that refonns to the existing 

system are necessary. 

Unfortunately, another three (3) years has passed and the SEC has not initiated 

any rulemakings to follow-up on the Concept Release and address the many identified 

problems in the current shareholder communications and proxy voting system. 

While we acknowledge the SEC's heavy workload under the Dodd-Frank and 

JOBS Acts, the Coalition believes strongly that there should not be any further delays-it 

is now time for the SEC to address the concerns identified in the Concept Release. 

2 
152 


81762.115

As the SEC itself noted in its Concept Release: "[w]ith 600 billion shares voted 

every year at more than 13,000 shareholder meetings, shareholders should be served by a 

well-functioning proxy system that promotes efficient and accurate voting."l 

The Coalition urges the members of this Subcommittee to request that the SEC 

tum to these issues and promptly initiate a series of rule makings to reform its shareholder 

communications and proxy rules. 

The Current Proxy System 

In order to promote an understanding of the problems in this area, let me explain 

in greater detail how the current proxy system works, and why the Coalition believes 

reforms are necessary. 

It is estimated that 75-80% of all public company shares in the United States are 

held in "street name," meaning in the name of a broker or a bank that holds the shares on 

behalf of its clients and customers, who are called the "beneficial owners." When shares 

are purchased in street name, the underlying beneficial owners of the shares are not 

registered on the books and records ofa public company. 

The street name system of stock ownership expanded after the Wall Street 

paperwork crisis in the 1970' s. The primary purpose of this system was-and still is 

today-to enable securities transactions to be processed and cleared in an efficient 

manner. 

Under SEC and stock exchange rules, brokers and banks are responsible for 

distributing annual meeting materials provided by companies (and requesting voting 

I Concept Release on the U.S. Proxy System, 75 Fed. Reg. 42,982, at 42,983 (July 22, 2010). 

3 
153 


81762.116

instructions) from beneficial owners who are holding their shares in street name. Since 

many shareholders do not attend annual meetings in person, companies need to solicit 

votes through a proxy system that functions in a similar fashion to the absentee balloting 

process used in federal and state elections. 

The U.S. proxy system is complicated and multi-faceted, involving several layers 

of intermediaries who are not the economic owners of corporate shares. This 

intermediation in the proxy process increases the complexity and the cost of processing 

proxy materials and tabulating votes. It also makcs it very difficult for companies to 

know who their shareholders are and to communicate with them in an effective manner. 

The proxy system and the SEC's rules have also not kept pace with the 

development of back office systems used in the securities industry, significant advances 

in the use and availability of communication technologies, and the growth of the Internet. 

Similarly, corporate governance practices have changed significantly since the 

1980's, when many ofthe SEC rules governing the proxy system were put in place. 

There has been a substantial move away from plurality voting in favor of majority voting 

for uncontested director elections. Shareholder proposals arc on the increase, as is voting 

support for them. The Dodd-Frank Act now requires companies to provide a regular "say 

on pay" advisory vote for their shareholders. And recent changes to New York Stock 

Exchange rules have limited broker discretionary voting. 

These changes have accelerated the need for companies to communicate more 

frequently, and on a more time-sensitive basis, with their shareholders. However, this is 

difficult to accomplish under the current proxy system, which is controlled by brokers 

and banks, and which classifies beneficial o\vners as either Objecting Beneficial Owners 

4 
154 


81762.117

("OBOs") or Non-Objecting Bcneficial Owners ("NOBOs"). Public companies arc not 

permitted to communicate directly with OBOs; and communication with NOBOs is 

expensive and restricted with respeet to the distribution of proxy materials. 

As you will see from this testimony, the public companies reprcscntcd by thc 

Coalition have one overriding goal in this area: they want to know who their shareholders 

are, and they want to be able to communicate directly with them. 

Public Company Concerns with the Current Proxy Communication and 

Voting System 

Public companies are understandably frustrated by a shareholder communications 

system that prevents them from knowing who many of their shareholders are and 

effectively communicating with them. Under the current structure, companies seeking to 

encourage more voting participation by beneficial owners, and engage in dialogue with 

them, cannot do so without using a complicated, circuitous, and expensive process that is 

largely outside their control. 

The Need for Direct Shareholder Communications 

Public companies want to have direct communications with their shareholders. 

The NOBO/OBO system impedes communications between shareholders and the 

companies they are invested in. Survey research has demonstrated that individual 

investors are confused by this classification system. In an age of instant communications 

and heightened shareholder empowerment, there is no reason to have this type of barrier 

to open and direct communications between a public company and its beneficial owners. 

5 
155 


81762.118

For these reasons, the Coalition supports the elimination of the NOB a/aBO 

classification system. This reform would ensure that public companies could have access 

to contact infonnation and share position for their beneficial owners and would be 

permitted to communicate with them directly. 

This reform would also bring the U.S. system in line with the capital market 

practices of other countries, where companies are entitled to receive information 

regarding the identities of their beneficial owners. As an example, the United Kingdom 

requires full transparency regarding the identity of individuals and institutions holding 

voting rights and/or beneficial owner interests, with civil and criminal penalties for a 

failure to make appropriate disclosures to public companies. 2 

Once public companies have access to information about their shareholders, they 

could assume the responsibility of distributing proxy materials directly to their 

shareholders, thereby facilitating direct communications with them. 

Some investors-both individual and institutional-may want to retain their 

anonymity, either for trading purposes or for proxy voting purposes, or both, and we 

anticipate that the system could provide for that. For example, those investors who wish 

to remain anonymous could be permitted to establish nominee accounts, or otherwise use 

custodial arrangements to maintain their anonymity. Nominee status and custodial 

arrangements are common methods for institutional investors to hold their shares 

anonymously, and these methods should not change under the proposed reform. 

Obviously, before any change is made to the NOB a/aBO system, there should be 

adequate notice to all investors, so that they have sufficient time to consider their options. 

2 See Sections 793-795 ofthe UK Companies Act 2006. 

6 
156 


81762.119

Other stakeholders in the proxy process have expressed similar concerns about the 

barriers to communicating with beneficial owners in the street name system. For 

example, the Council of Institutional Investors commissioned a study on the proxy 

processing system, which was released in February of201 0. 3 The study was critical of 

the NOBO/OBO system and supportive of measures to increase the potential of direct 

communications between companies and their shareholders. 4 

The Need for an Improved Proxy Voting System 

Other concerns have been raised about the mechanics of the current proxy voting 

system, which needs to be improved to ensure that vote counts are accurate, verifiable, 

and auditable. 

Reports in the news media of voting miscounts and delays in determining election 

results by proxy service providers have raised questions about the integrity of the proxy 

voting process. Additionally, there is no ability for an independent third-party to audit 

and verify the results of a close election. 

These proxy voting issues need to be addressed, as increased investor activism 

will certainly cause many more close votes on shareholder proposals, director elections, 

and other matters. 

The integrity of the proxy voting process is essential to the proper 

functioning of our capital markets. Proxy voting should be fully transparent and 

verifiable, starting with a list of beneficial owners eligible to vote at a shareholder 

meeting and ending with the final tabulation of votes cast at the shareholder meeting. 

3 Alan L. BeUer and Janet L. Fisher, The OBOINOBO Distinction in Beneficial Ownership: Implications 

for Shareowner Communications and Voting (Feb. 18,2010). 

4 See Letter from Glenn Davis, Senior Research Associate, Council ofinstitutional Investors, to Elizabeth 

M. Murphy, Secretary, Securities and Exchange Commission, SEC File No. S7-14-10 (Oct. 14,2010). 

7 
157 


81762.120

The vote counts on matters before a shareholder meeting should be auditable and capable 

of third-party verification, so that a validation of the votes of all shareholders can occur. 

Public Company Concerns with Proxy Advisory Firms 

Public companies are also concerned about the role and activities of the private 

firms providing proxy advisory services to institutional investors, which operate today 

with very little regulation or oversight. The SEC also raised this issue in its 20 10 

Concept Release. 

There is a lack of transparency in the way proxy advisory firms operate, with 

insufficient information available about their standards, procedures, and methodologies. 

Conflicts of interest exist in several of their business practices; and concerns exist about 

their use of incorrect factual information in formulating specific voting 

recommendations. 

These firms have considerable influence in the proxy voting process, as they 

generate voting recommendations for their clients, and, in fact, make voting decisions for 

some of their clients. The clients of these firms are institutional investors, including 

pension plans, mutual funds, hedge funds, and endowments. 

Despite their large role in proxy matters, proxy advisory firms develop their 

policies using a "one-size-fits-all" approach that generally applies the same standards to 

all public companies, instead of evaluating the specific facts and circumstances of each 

company they evaluate. 

One of the reasons that proxy advisory firms have become so powerful is that 

many interpret SEC and Department of Labor rules and guidance as requiring 

8 
158 


81762.121

institutional investors to vote all their proxies at shareholder meetings as a part of the 

fiduciary duties they owe to their clients, investors, and beneficiaries. These regulations 

and guidance apply to investment companies, investment advisers, and many retirement 

and pension plans. 

Many institutional investors and their third-party investment managersespecially mid-size and smaller firms--choose to reduce costs by not having in-house 

staff to analyze and vote on proxy items. Instead, these institutional investors and 

managers typically outsource their voting decisions to proxy advisory firms. 

The proxy advisory industry is subject to a regulatory framework that can best be 

described as a patchwork quilt. As an example, the largest proxy advisory firm, 

Institutional Shareholder Services ("ISS"), has chosen to register under the Investment 

Advisers Act of 1940. However, the SEC's rules for investment advisers do not reflect 

the unique role that these advisory firms perform in the proxy voting process. 

The second biggest proxy advisory firm, Glass Lewis, is not registered as an 

investment adviser and is not currently subject to any regulatory supervision. For 

example, the SEC just sanctioned ISS under the Investment Advisers Act for failing to 

establish or enforce written policies and procedures to prevent the misuse of material, 

non-public information by ISS employees with third parties. 5 As a non-registered entity, 

Glass Lewis is not subject to a number of provisions of the Investment Advisers Act and 

the SEC rules implementing the Act. 

5 See Order Instituting Administrative and Cease-and-Desist Proceedings and Imposing Remedial 

Sanctions and a Cease-and-Desist Order, In the Matter of Institutional Shareholder Services, Inc., 

Administrative Proceeding File No. 3-15331, May 23,2013, available at 

http://www.sec.gov/litigation/admin/2013/ia-3611.pdf. 

9 
159 


81762.122

Additionally, the SEC has created an exemption from its proxy rules for these 

firms, so they are not required to abide by solicitation and disclosure rules that apply to 

other proxy participants. Thus, their reports, in contrast to company proxy materials, are 

not publicly available, even after annual meetings. 

This patchwork system should not be permitted to continue, and these firms 

should be subject to more robust oversight by the SEC and the institutional investors that 

rely on them. For example, the current exemption from the proxy rules that proxy 

advisory firms rely on could be conditioned on their meeting certain minimum 

requirements governing their activities and conduct. The SEC should also consider a 

requirement that all proxy advisory firms register under the Investment Advisers Act of 

1940, under a targeted regulatory framework that reflects the unique role they perform in 

the proxy voting process. 

As noted earlier, there is a need for greater transparency about the internal 

procedures, policies, standards, methodologies, and assumptions used by these firms to 

develop voting recommendations. 

And there needs to be attention to the problem of inaccuracies in the reports 

provided by proxy advisory firms. One firm-ISS-provides drafts (on a very short 

turnaround) only to S&P 500 companies and the other major proxy advisory firm-Glass 

Lewis--does not even do that. 

All proxy advisory firms should be required to provide each public company with 

a copy of their draft reports, in advance of dissemination to their clients, to permit a 

company to review and correct any inaccurate factual information contained in these 

10 
160 


81762.123

reports. Shareholders should not be voting based on inaccurate information in the reports 

of proxy advisory firms. 

Another problem is that Glass Lewis refuses to provide a copy of its final reports 

to any public company that does not pay to subscribe to its services. And for those who 

do pay, both firms are attempting to impose unreasonable restrictions on a company's use 

of the information. It does not seem right that companies should have to pay a proxy 

advisory firm to find out what their shareholders are being told about the matters being 

voted on at a shareholder meeting. 

Conflicts of interest within these firms also need to be addressed. One proxy 

advisory firm, for example, provides corporate governance and executive compensation 

consulting services to public companies, in addition to providing voting 

recommendations to its institutional clients on proxy matters for these same companies. 

Another conflict that exists is proxy advisory firms providing voting 

recommendations on shareholder proposals submitted to companies by their institutional 

investor clients. 

These conflicts should be specifically disclosed to clients of proxy advisory firms 

so that they may evaluate this information in the context ofthe firms' voting 

recommendations. 

Along with considering greater regulatory oversight of proxy advisory firms, the 

SEC and Department of Labor should review the existing regulatory framework 

applicable to the use of proxy advisory firms by institutional investors. This review 

should include the guidance and interpretive letters that have been issued over the years 

on thls subject. The SEC and Department of Labor should ensure that institutional 

11 
161 


81762.124

investors are exercising sufficient oversight over their usc of proxy advisory services, in a 

manner consistent with their fiduciary duties. 

Next Steps 

As noted earlier, it has been more than 25 years since the SEC's proxy rules have 

been updated and nine (9) years since the Business Roundtable filed its Petition for 

Rulemaking with the SEC, urging reform to the shareholder communications and proxy 

voting system. 

The SEC must turn its attention to reforming the proxy system, addressing the 

issues raised in its 2010 Concept Release. We anticipate it would do so through a series 

of rule makings in which it would obtain the input of public companies and other 

stakeholders in the proxy process. 

The Coalition urges the members of this Subcommittee to request SEC action in 

this area. 

Thank you for the opportunity to present the Shareholder Communication 

Coalition's views on these important issues. At the appropriate time, I am happy to 

answer any questions that the members of the Subcommittee may have. 

12 
162 


81762.125

Testimony of 

Michael McCauley 

Senior Officer - Investment Programs & Governance 

Florida State Board of Administration (SBA) 

before the 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

ofthe 

United States House of Representatives Committee on Financial Services 

Wednesday, June 5,2013 

Examining the Market Power and Impact of Proxy Advisory Firms 
163 


81762.126

Chairman Garrett, Ranking Member Maloney, and Members of the Subcommittee: 

Good moming. I am Michael McCauley, Senior Officer Investment Programs and 

Govemance, for the Florida State Board of Administration, or "SBA." I am pleased to 

appear before you today on behalf of the SBA. 

My testimony includes a brief overview of the Florida State Board of Administration and 

its investment approach, followed by a discussion of our proxy voting process and 

procedures and our use of proxy advisers to assist the SBA in fulfilling its proxy voting 

obligations. I will also discuss some proposed reforms that the SBA believes will make 

proxy advisers more transparent to the market and more accountable to their clients. 

Florida State Board of Administration 

The Florida State Board of Administration manages more than thirty separate 

investment mandates and trust funds, some established as direct requirements of 

Florida law and others developed as client-initiated trust arrangements. In total, the 

SBA manages approximately $170 billion in assets, providing retirement benefits for 

more than 1 million current and former employees of Florida state government, public 

schools, universities and colleges, and many cities and local government districts. One 

of these funds, the Florida Retirement System Pension Plan ("FRS pension plan"), 

accounts for approximately 80 percent of the total assets under management. The FRS 

pension plan provides more than $7.3 billion in annual benefit payments to more than 1 

Testimony- Page 1 
164 


81762.127

million individuals. 1 The SBA has a long history of successful fund management. 2 

Under Florida law the SBA manages the funds under its care according to fiduciary 

standards similar to those of other public and private pension and retirement plans: The 

SBA must act in the best interests of the fund beneficiaries. This standard 

encompasses all activities of the SBA, including the voting of all proxies held in funds 

under SBA management. 

Proxy Voting 

Proxy voting is an integral part of managing assets in the best interests of fund clients 

and beneficiaries. In fiscal year 2012, the Florida State Board of Administration 

executed votes on thousands of public companies. 3 During the most recent trailing 

twelve months ended March 31,2013, the SBA executed votes at 9,534 public 

companies on 85,408 individual voting items, including director elections, audit firm 

ratification, executive compensation, and merger approval. Of the 85,408 voting items 

over the last twelve months ending March 31,2013, the SBA cast 80 percent "for," 16 

percent "against" and 3 percent "withhold." On less than 1 percent of ballot items, the 

SBA abstained or did not vote. 

1 "Annual Report, The Florida Retirement System and Other State Administered Systems,' July 1, 2010-

June 30, 2011, at 41, https:llwww.rol.frs.state.fi.us/forms/2011-12 Annual Report. pdf. 

2 "Overview of the State Board of Administration of Florida as of December 31,2012,' 

http://www.sbafia.com/fsb/LinkClick.aspx?fileticket=gXE1 NoON3YI%3d&tabid=997&mid=2293. 

3 "Proxy Voting: Summary Report Fiscal year 2012," State Board of Administration of Florida, at 12, 

http://www.sbafia.com/fsb/portals!l nternetiCorpGov/Reports Publications/2 0 121 031 S BAProxyVotingS u m 

mary. pdf. 

Testimony- Page 2 
165 


81762.128

The SBA makes all proxy voting decisions independently. To ensure that the SBA 

meets its fiduciary obligations, it established the Corporate Governance & Proxy Voting 

Oversight Group ("Proxy Committee") as one element in an overall enterprise risk 

management program. The Proxy Committee is comprised of several SBA staff 

members including myself, the Deputy Executive Director, the Chief Risk & Compliance 

Officer, the Co-Senior Investment Officers over Global Equity, and the Director of 

Investment Risk Management. The Proxy Committee, which met five times in 2012, 

oversees the SBA's proxy voting process and reviews and approves significant and 

contested matters regarding corporate governance and voting. 

The SBA votes based on written corporate governance principles and proxy voting 

guidelines it develops internally for common issues expected to be presented for 

shareowner ratification. The SBA's proxy voting guidelines reflect its belief that good 

corporate governance practices will best serve and protect the funds' long-term 

investments, and are reviewed and approved by the SBA's Investment AdviSOry Council 

and Board of Trustees on an annual basis. 

The SBA's voting policies are developed using ernpirical research, industry studies, 

investment surveys, and other general corporate finance literature. SBA voting policies 

are based both on market experience and balanced academic and industry studies, 

which aid in the application of specific policy criteria, quantitative thresholds, and other 

qualitative metrics. For 2012, the SBA issued guidelines for more than 350 typical 

voting issues and voted at least 80 percent of these issues on a case-by-case basis, 

following a company-specific assessment. The SBA discloses all proxy voting decisions 

Testimony- Page 3 
166 


81762.129

once they have been made, normally seven to ten days prior to annual shareowner 

meetings. Historical proxy votes are also archived for a period of five years and are 

available electronically on the SBA's website. 

To supplement its own proxy voting research, the SBA purchases research and voting 

advice from several outside firms, principally three leading proxy advisory and corporate 

governance firms: Glass, Lewis & Co. ("Glass Lewis"), Manifest Information Services 

LLC ("Manifest"), and MSCllnstitutional Shareholder Services ("ISS"). The SBA uses 

additional external research providers for more narrow and specialized analyses 

covering executive compensation. Glass Lewis's research covers the entire U.S. stock 

universe of Russell 3000 companies and virtually all non-U.S. equities. Manifest 

provides analYSis of proxy issues and meeting agendas on a non-advisory basis, with a 

primary emphasis on European and large capitalization global companies. ISS provides 

specific analysis of proxy issues and meeting agendas on all publicly traded U.S. and 

non-U.S. equity securities. Additionally, the SBA executes its global equity votes on 

ISS's voting platform, ProxyExchange.4 

When making voting decisions, the SBA considers the research and recommendations 

provided by Glass Lewis, Manifest and ISS, along with other relevant facts and 

research, and the SBA's own proxy voting guidelines.5 But the SBA makes voting 

decisions independently and in what it considers to be the best interests of the 

beneficiaries of the funds it manages. Proxy advisor and governance research firm 

4 Ibid. at 11. 

5 "Corporate Govemance Principles & Proxy Voting Guidelines,' State Board of Administration of Florida 

(2012), htlp:/lwww.sbafia.com/fsbIUnkClick.aspx?fileticket=KY96Es7W718%3d&tabid=1439&mid=3907. 

Testimony- Page 4 
167 


81762.130

recommendations inform but do not determine how the State Board of Administration 

votes. And they do not have a disproportionate effect on SBA voting decisions. In fiscal 

year 2012, the votes that SBA executed correlated with the recommendations of one 

firm 67 percent of the time.s Other historical reviews of SBA voting correlation have 

shown both lower and higher correlations with individual external proxy adviser 

recommendations, depending on both the time period studied and specific voting 

categories in question. Over the last few years, the SBA has voted with management 

(the "management-recommend ed-vote") more than 80 percent of the time across all 

voted portfolios. 

On advisory votes on executive compensation ("say on pay"), perhaps the most closely 

tracked proxy adviser recommendations, the SBA clearly charted its own path. In 2011, 

ISS recommended votes against 12.2 percent of management say-on-pay proposals. 

The SBA tracked ISS's recommendations less than half the time, voting against 25.4 

percent of management say-on-pay proposals. Among all SBA 'against' voting 

decisions in 2011, the SBA vote deviated 51.9 percent of the time when compared to 

the ISS recommended vote. SBA voting patterns on say-on-pay ballot items, both 

during fiscal-year 2012 and fiscal-year-to-date 2013, have not been dissimilar. 

Recommendations for Reform 

While the Florida State Board of Administration acknowledges the valuable role that 

proxy advisers play in providing pension funds with informative, accurate research on 

e Ibid. at 21 

Testimony- Page 5 
168 


81762.131

matters that are put before shareowners for a vote, we believe proxy advisory firms 

should provide clients with substantive rationales for vote recommendations, minimize 

conflicts of interest and have appropriate oversight. Toward that end, the SBA believes 

that proxy advisers should register as investment advisers under the Investment 

Advisers Act of 1940. 

Registration would establish important duties and standards of care that proxy advisers 

must uphold when advising institutional investors. Additionally, the mandatory 

disclosures would expose conflicts of interest and how they are managed, and establish 

liability for firms that withhold information about such conflicts. Mandatory disclosures 

should also include material information regarding the process and methodology by 

which the firms make their recommendations, aimed at allowing all stakeholders to fully 

understand how an individual proxy adviser develops voting recommendations. This 

would make adviser recommendations more valuable to institutional investor clients and 

more transparent to other market participants. In this way registration would 

complement the aims of existing securities regulation, which seeks to establish full 

disclosure of all material information. 

Thank you, Mr. Chairman for inviting me to participate at this hearing. I look forward to 

the opportunity to respond to any questions. 

Testimony- Page 6 
169 


81762.132

National Investor Relations Institute 

225 Reinekers Lane, Suite 560, Alexandria, VA 22314 

p: (703) 562-7700 f: (703) 562-7701 

www.niri.org 

WRITTEN TESTIMONY 

Jeffrey D. Morgan, FASAE, CAE 

President & CEO 

National Investor Relations Institute 

June 5, 2013 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

United States House of Representatives 

Hearing on "Examining the Market Power and Impact of Proxy Advisory Firms" 
170 


81762.133

INTRODUCTION 

My name is Jeffrey D. Morgan and I am President and CEO of the National Investor Relations 

Institute. Founded in 1969, NIRI is the professional association of corporate officers and investor 

relations consultants responsible for communication among corporate management, 

shareholders, securities analysts, and other financial community constituents. NIRI is the largest 

professional investor relations (IR) association in the world with more than 3,300 members 

representing over 1,600 publicly held companies and over $9 trillion in stock market 

capitalization. 

NiRi appreciates the opportunity to present our views on the regulation of proxy advisory firms 

and other ways to improve the ability of public companies (also known as "issuers") to 

communicate with their investors. NlRl thanks Chairman Scott Garrett, Ranking Member 

Carolyn Maloney, and the Subcommittee's staff for scheduling this hearing on these important 

issues. 

BACKGROUND 

NIRI supports transparent, fair, efficient, and robust capital markets, which are essential to 

promoting innovation, sustainable job creation, and a strong U.S. economy. Vital to such capital 

markets are ensuring that public companies can communicate effectively with their shareholders 

and that investors receive accurate information. We need to have an accurate and transparent 

proxy system that allows efficient two-way corporate-investor communications and ensures 

equality among shareholders. 

Shareholders are the ultimate owners of our public companies and they must have accurate and 

timely information so they can make informed decisions when they buy or sell a company's 

shares or cast their ballots at shareholder meetings. IR professionals playa dual role in this 

important two-way communication process. They work to ensure that all investors have fair 

access to the publicly available and material information about a company's financial results, 

future prospects, and corporate governance. IR professionals also make sure that shareholders' 

views are heard by management and directors. 

My testimony will focus on two concerns that relate to the ability of companies to reach their 

investors: I) the role of loosely regulated proxy advisory firms and 2) the outdated SEC rules 

that can prevent companies from effectively communicating with shareholders on a timely basis. 

NIRI has a long record of seeking reforms on these two issues. NIRI has submitted and also 

joined other organizations in submitting various comment letters to the SEC on ways to reform 

the archaic and complex proxy communications system an outdated system that has not kept 

pace with globalization, technological innovation, and in general, more modem times. 

THE GROWING INFLUENCE OF PROXY ADVISORY FIRMS 

Before outlining our suggested reforms on proxy advisory firms, it may be helpful to review how 

these firms became so powerful. Over the past 25 years, there has been a fundamental shift in 

who owns shares in U.S. public companies. in 1987, mutual funds, pension funds, and other 

2 
171 


81762.134

institutional investors owned 47 percent of the shares of the largest 1,000 U.S. companies. By 

2007, these institutions had increased their ownership to 76 percent.! Consequently, these 

institutions and their proxy advisors now exercise tremendous influence when companies hold 

their annual meetings each year to seek investor support on director candidates, executive 

compensation, potential takeover offers, and other material matters. 

Unlike many individual investors who vote sporadically at annual meetings, mutual fund and 

pension fund managers are required to vote all their shares on every matter, a result of various 

interpretations by the SEC and the Department of Labor. For the largest institutions, that means 

that they must vote on more than 100,000 ballot items each year. More than 80 percent of U.S. 

companies hold their annual meetings each spring, which further intensifies the voting workload 

for institutional investors. In order to manage the costly and time-consuming responsibility of 

voting all these ballots, many institutions and their investment managers commonly outsource 

this responsibility to a proxy advisory firm. In a 2004 comment letter, the SEC further 

encouraged this practice when it noted that investment managers avoid potential conflicts of 

interest if they followed the advice of an outside proxy advisor.2 Should they decide to override 

their proxy advisor, some institutions require an extra level of documentation to support the 

investment manager's decision, which can later become a key factor in that firm's ability to 

attract capital from large pension funds and endowments that look to understand each time an 

investment manager diverges from a proxy advisor's recommendation. 

Today, two firms, Institutional Shareholder Services (ISS) and Glass Lewis & Co., dominate the 

proxy advisory business. While there are varying estimates of their influence, it has been 

estimated that ISS has a 61 percent market share, while Glass Lewis has a 36 percent share. J 

According to a 2007 General Accounting Office study, the two firms collectively had more than 

2,000 institutional clients with $40.5 trillion in assets.4 

Today, proxy advisory firms remain largely unregulated and unsupervised, while substantial 

concerns have been raised by companies and academics about: (1) a lack of transparency 

concerning their standards, procedures, and methodologies; (2) the risk that their voting 

I "A Call for Change in the Proxy Advisory Industry Status Quo." Center on Executive Compensation (January 

2011): 15-16, avaiJable at: http://www.executivecompensation.orgldocs/cll07b%20Proxv%20Advisorv%20White%20Paper.pdf 

2 "Investment Advisers Act of 1940-Rule 206(4)-6: Egan-Jones Proxy Services," SEC letter to Kent S. Hughes, 

May 27, 2004, available at: http://www.sec.gov/divisions/investmentinoactioniegan052704.htm 

3 Tamara C. Belinfanti, "The Proxy Advisory and Corporate Governance Industry: The Case for Increased 

Oversight," Stanford Journal of Law, Business & Finance 14 (Spring 2009): 395. The author, an associate professor 

at New York Law SchooL attached the comment to a letter filed with the SEC on Oct. 20, 20 I O. That letter is 

available at; http://www.sec.gov/comments/s7-14-10/s71410-183.pdf 

4 See Government Accountability Office, Corporate Shareholder Meetings: Issues Relating to Firms That Advise 

Institutionallnveslors on Proxy Voting. a Report 10 Congressional Requesters, GAO-07-765 (Washington, June 

2007): 13, http://www.gao.gov/new-items/d07765.pdf 
172 


81762.135

recommendations may be based on incorrect factual information; and (3) the inherent conflicts of 

interest posed by several of their business practices. 

Given their large roster of clients, the two largest advisory firms can have extraordinary 

influence on the outcome of director elections and other proxy voting matters. Collectively, ISS 

and Glass Lewis clients may own between 20 and 50 percent of a large or mid-cap company's 

shares. While not all institutions follow the advice of their proxy advisors in all cases, many of 

them do so, particularly the small and medium-size institutions that don't have their own 

corporate governance staffs. Although the influence of the proxy advisors varies by company 

and subject matter, governance experts have found that a negative proxy advisor 

recommendation can lead to a 15 to 30 percentage point differential in support for management. 

As Leo E. Strine Jr., vice chancellor ofthe Delaware Court of Chancery, has observed; 

"Following ISS constitutes a form of insurance against regulatory criticism, and results in ISS 

having a large sway in the affairs of American corporations."s 

The influence oflSS and Glass Lewis has increased again when the Dodd-Frank Wall Street 

Reform and Consumer Protection Act required U.S. companies to hold shareholder "Say on Pay" 

votes on their executive compensation practices. In 2012, companies receiving a negative 

recommendation from IS S on executive pay saw their average support levels fall from 94 to 64 

percent, according to Semler Brossy, an executive compensation consultant. 6 

Unlike investors and companies whose proxy filings are subject to review and sanctions by the 

SEC, proxy advisors generally are exempt from regulation. Although ISS has registered with the 

SEC as a registered investment advisor, the SEC does not provide systematic oversight over the 

proxy firms' policies and research processes, how the firms interact with companies, and how 

they communicate with investors and other market participants. In its 20 I 0 concept release on 

the U.S. proxy voting system, the SEC acknowledged the significant role of proxy advisors, but 

the Commission has not yet taken any formal action to address their research practices. 7 While 

Commission officials indicated in June 2012 that they were working on this, it does not appear 

s Leo E. Strine Jr., "The Delaware Way: How We Do Corporate Law and Some ofthe New Challenges We (And 

Europe) Face," Delaware Journal o/Corporale Law 30 (2005): 688, available at: http://ssm.comiabstract=893940 

See also "A Call for Change in the Proxy Advisory Industry Status Quo," Center on Executive Compensation 

(January 2011): 15-16, available at: http://www.executivecompensation.orgldocs!cll07b%20proxy%20Advisory%20White%20Paper.pdf 

6 See Semler Brossy, "2012 Sayan Pay Results: Year-End Report" (Dec. 31, 2012) (this report analyzed vote results 

from the Russell 3000 companies that held pay votes in 2012), available at: http://www.semlerbrossy.com/wpcontentluploads120 13/0 1/SB CO-SOp-Y ear-End-Report.pdf 

7 On May 23, 2013, the SEC announced a settlement with ISS overthe firm's failure to adequately safeguard 

confidential proxy voting information from more than 100 clients. That case resulted from a whistleblower's 

complaint that alleged that an ISS employee accepted meals, tickets for concerts and sports events, and other 

benefits from a proxy solicitor in exchange for the confidential information. Without the whistleblower, it is unlikely 

that the SEC would have uncovered this wrongdoing on its own. While this case did not involve ISS research 

analysts, it does illustrate that more robust regulation is needed and raises questions about the ability ofiSS to 

manage its conflicts of in teres!. See "SEC Charges Institutional Shareholder Services in Breach of Clients' 

Confidential Proxy Voting Information" (May 23, 2013), available at: http://www.sec.gov/newslpress/2013/2013-

92.htm 

4 
173 


81762.136

that this issue is as high a priority as other agency initiatives, including various mandates under 

the Dodd-Frank Act and the JOBS Act, and resources appear to have been allocated accordingly 

thus far. 8 

Lack of Transparency and Opportunities for Corporate Input 

Proxy advisory firms playa major role in shaping how institutional investors view corporate 

governance issues, but the advisors' policy development process and methodologies are largely 

opaque, with limited opportunities for corporate input. In some cases, proxy advisory firms work 

with their clients to develop unique voting guidelines. However, more often than not, investors 

accept benchmark voting guidelines policies developed by the proxy advisory firms. While some 

clients provide input on particular voting policies, the reality is often that the proxy advisory firm 

suggests the policy; and voting patterns at companies suggest that many institutions vote 

according to those policies. The end result of this process is not a unique set of voting 

instructions for each institutional client, but a set of guidelines and policies that have been 

developed by the proxy advisory firm and are used by most ofthe firm's clients. As a general 

matter, the proxy firms do not evaluate the facts and circumstances of each public company with 

respect to the matters to be voted on; instead, their voting guidelines encourage a procrustean 

"one-size-fits-all" or "check the box" methodology. 

Since the global economic crisis of 2008-09, we believe that proxy advisors have faced 

increasing pressure from their investor clients to constrain costs. This pressure has further 

encouraged the proxy advisors to adopt "one-size-fits-all" voting policies that are less costly to 

apply. We also believe that proxy advisors have responded by cutting their full-time research 

staffs, hiring temporary employees who have little training in U.S. corporate governance, and 

shifting work to low-cost labor locations outside the United States. 

While ISS and Glass Lewis have responded to corporate complaints and released more details on 

their policies in recent years, these firms do not fully disclose, as one example, all the 

methodologies that they use to develop their vote recommendations, including their evaluation of 

a company's equity incentives or other pay practices. 

While ISS now provides a brief comment period (typically less than a month) each fall for 

issuers to weigh in on selected policy updates, ISS rarely makes significant policy changes in 

response to corporate input. The proxy advisors could do much more to ensure that their policies 

and research methodologies are fully transparent. They should also disclose the academic 

research, if any exists, that demonstrates that their voting policies generate long-term shareholder 

value.9 Finally, proxy advisors should be required to publicly file their reports with the SEC, so 

companies and investors can better judge the value of the advice provided. 

8 The SEC has designated an official in its Division of Corporation Finance to receive corporate complaints about 

proxy advisors, but the agency has not publicly disclosed details on those complaints or any official action taken by 

Commission staff. 

'Researchers at Stanford University have found that there is a negative correlation between the proxy firms' 

compensation policies and shareholder value. See David F. Larcker et aI., "Outsourcing Shareholder Voting to Proxy 

Advisory Firms" (working paper, Rock Center for Corporate Governance at Stanford University, May 10, 2013), 

5 
174 


81762.137

Most Companies Have No Chance to Review Advisors' Reports for Accuracy 

One of the most serious concerns with current proxy advisor policies is that most companies 

have no or very limited opportunity to review the advisors' reports on their annual meetings 

before investors cast votes based on those recommendations. This increases the risk that the 

advisory firms will make recommendations that are based on inaccurate factual information. This 

is especially a concern in the area of executive compensation, where pay arrangements are 

complex and the advisors use different methodologies for calculating the value of certain 

incentive arrangements. These errors are not surprising given the large volume of proxy 

statements each spring that are reviewed by the advisors' research teams, who have limited 

training, work long hours during proxy season, and include temporary and overseas employees. 

If a company spots an error and contacts the proxy advisor to complain, the proxy advisor may 

send an "alert" to its clients, but those alerts may arrive too late. Given their heavy proxy season 

workloads each spring, many institutional investors vote their shares immediately after receiving 

their proxy advisor's recommendation and some wit! not bother to change their vote if an alert is 

issued. 

So far, ISS and Glass Lewis have resisted requests to allow all companies an opportunity to 

review their reports for accuracy before they are released to investors. As a result, many 

companies are blind-sided by negative recommendations and have limited time to correct that 

information and make their case to their investors, many of whom have already voted. In 

response to corporate concerns, ISS does provide a limited opportunity (i.e., 24 to 48 hours) for 

S&P 500 firms to review a draft copy of their reports. This review process is quite helpful for 

these large-cap companies because they may spot inaccurate factual information, or notice an 

improper application of ISS policies to the company's specific circumstances. In addition, a 

company may be able to easily address the concerns (e.g., by adopting a new board policy on 

severance payor providing more disclosure) that led to the negative ISS recommendation. 

Institutional investors also benefit from this review process because they receive reports that are 

more accurate and complete and have to change their votes less frequently. Regrettably, ISS has 

declined to offer this necessary safeguard to mid-cap and smaller companies, which typically are 

less familiar with proxy advisor policies and could equally benefit from this review process. ISS 

also has restricted the ability of companies to share final ISS reports with their outside lawyers, 

pay consultants, or proxy solicitors, a practice that has further hindered the ability of companies 

to identifY inaccuracies and respond quickly. Glass Lewis has declined to make its drafts 

available to any U.S. company. 

In light of the significant role that proxy advisors play in U.S. corporate governance, the SEC 

should act to ensure that companies have a reasonable opportunity to ensure that their investors 

receive accurate information. 

Inherent Conflicts of Interest 

The inherent conflicts of interest posed by the proxy advisors' business practices also need to be 

addressed by regulators. In addition to assessing corporate disclosure practices and delivering 

available at: http://www.niri.orglOther-Contentisampledocs/David-Larcker-SIanford-University-el-al-OutsourcingShareho Ider-V oling-to-Proxy-Advisory-Firms.aspx 

6 
175 


81762.138

voting recommendations to investors, ISS sells corporate governance consulting and executive 

compensation data to companies. For example, ISS offcrs a consulting service to help companies 

determine iftheir equity plans meet ISS' approval criteria; and it provides a service to evaluate 

"corporate sustainability," which involves a review of certain environmental and social issues 

facing a company. While ISS has stated that it maintains an internal firewall between its 

corporate and institutional businesses, many companies believe that they need to purchase ISS' 

corporate consulting services in order to get a fair hearing from ISS' institutional research 

analysts. In addition, it appears unlikely that ISS will abandon its profitable corporate advisory 

business, given that it has been growing more quickly than its institutional proxy advisory I1l • business. 

Another conflict of interest arises when an institutional client of a proxy advisor firm is also the 

proponent of a specific shareholder proposal -- or instigates a "vote no" campaign against 

directors -- that will be subject to a voting recommendation by that same proxy firm. ISS and 

Glass Lewis have many clients that are public pension funds or labor union funds, which are 

among the most aggressive filers of shareholder proposals and organizers of "vote no" efforts. 

Glass Lewis is owned by the Ontario Teachers' Pension Plan Board, which manages a fund with 

more than $100 billion in assets. The influence of activists can be seen in the voting policies of 

the proxy advisors. As James K. Glassman and J.W. Verret observed in a recent academic paper 

on proxy advisors, both proxy firms also have shown a tendency toward ideological bias in their 

recommendations, eSfecially on issues that involve labor union power, executive compensation, 

and the environment. I 

Given that proxy advisors are critical intermediaries between companies and their institutional 

investors, the proxy firms should be required to provide full disclosure on all of these conflicts of 

interest so investors can adequately judge whether to follow their recommendations. 

Recommended Reforms for Proxy Advisory Firms 

NIRI, as part of the Shareholder Communications Coalition (which includes the Society of 

Corporate Secretaries and the Business Roundtable), has urged the SEC for years to take action 

to address the business practices of proxy advisors. In recent years, there has been a growing 

chorus of companies and former and current SEC officials who believe that urgent action is 

needed. 12 Unfortunately, the SEC has failed to act on these critical issues, but we hope that this 

Subcommittee concludes that these reforms should be a greater priority. 

10 See MSCIInc., Form IO-K for the Year Ended December 31, 2012, (March 1,2013): 54, available at: 

https:llwww.sec.gov/Archives/edgar/data/1408198/000119312513087988/d448124dI0k.htm#toc448124 II 

(MSCI is the corporate parent ofISS). 

11 James K. Glassman and J. W. Verret, BHow to Fix OUT Broken Proxy Advisory System," Mercatus Researcht 

George Mason University (April 16, 2013), available at: 

http://www.shareholderforum.com/e-mtg/Librarv/20 13 0416 Mercatus-report.pdf 

12 Former SEC Chairman Harvey Pitt and former Commissioner Paul Atkins are among the ex-agency officials who 

have voiced concern over the role of proxy advisors. More recently, Commissioner Daniel M. Gallagher raised a 

series of thoughtful questions about proxy advisors that regulators and investors should address. See Commissioner 

Daniel M. Gallagher, "Remarks at 12th European Corporate Governance & Company Law Conference" (Dublin, 

Ireland, May 17,2013), available at: http://www.sec.gov/news/speechl2013/spch051713dmg.htm 

7 
176 


81762.139

The following is a summary of our recommendations: 

1. Proxy advisory firms should be subject to more robust oversight by the SEC. All proxy 

firms should be required to register as investment advisers and be subject to the 

regulatory framework under the Investment Advisers Act of 1940. In addition, the SEC's 

Division of Corporation Finance, which oversees corporate disclosures and proxy issues, 

should playa prominent role in providing oversight. 

2. The SEC should adopt new regulations that include minimum standards of professional 

and ethical conduct to be followed by the proxy advisory industry. The goal of a uniform 

code of conduct -- which should address conflicts of interest, transparency of processes, 

and accuracy of factual information -- should be to improve the quality and reliability of 

the analysis and advice provided by proxy advisory firms. I3 

3. These SEC regulations should require full disclosure of cO,!jlicts of interest. A proxy 

advisory firm should publicly disclose its relationship with any client who is the 

proponent of a shareholder proposal or a "vote no" campaign, whenever the proxy 

advisory firm is issuing a recommendation to other clients in favor of the same proposal 

or "vote no" campaign. 

4. The SEC should address whether a proxy advisory firm should be allowed to offer 

consulting services to any public company for which it is providing recommendations on 

how investors should vote their shares. If a proxy advisory firm is allowed to offer such 

consulting services, consideration should be given to ensure there is a complete 

separation of proxy advisory activities from all other businesses of the firm, including 

consulting and research services. 

5. Given the tremendous influence of proxy advisory firms, there should be greater 

transparency about the internal procedures, guidelines, standards, methodologies, and 

assumptions used in their development of voting recommendations. This is particularly 

the case where the advisors apply policies without taking into account company-specific 

or industry-specific circumstances in making voting recommendations. This increased 

transparency would enable shareholders and companies to better evaluate the advice 

rendered by proxy advisory firms. These firms should be required to maintain a public 

record of all their voting recommendations. The SEC should also consider requiring the 

disclosure of the underlying data, information, and rationale used to generate specific 

voting recommendations. These disclosures could be made within a reasonable time after 

the recommendation has been made and still be relevant and useful to companies, 

investors, academics, and others who study the influence of proxy firms. 

11 The concern over the role of proxy advisors is not limited to the United States. As noted in a recent speech by 

Commissioner Gallagher, the European Securities and Markets Authority has called on proxy advisors to adopt a 

code of conduct that addresses conflicts of interest and fosters transparency to ensure the accuracy and reliability of 

the advice provided to investors. 
177 


81762.140

6. Proxy advisoryfirms should be required to provide all public companies with draft 

reports in advance of distribution to their clients, to permit companies to review the 

factual information contained in these reports for accuracy. Companies should be 

allowed a reasonable opportunity (such as 48 hours) to conduct this review and to 

respond to any factual errors. The SEC should consider whether to require proxy advisors 

to include in their reports any information they receive from a company, or, at a 

minimum, indicate in that report that a company disagrees with a particular factual 

assertion. 

7. Proxy advisory services should disclose publicly and promptly any errors made in 

executing or processing voting instructions on a particular proxy vote. 

MODERNIZING SHAREHOLDER COMMUNICATIONS 

NIRI appreciates this Subcommittee's interest in exploring ways to modernize the current proxy 

system, including current disclosure practices to improve communications between public 

companies and their shareholders. 

NIRI supports measures to improve the V.S. proxy system, the roots of which were established 

more than 30 years ago. NIRI believes these principles are critical to ensuring confidence in V.S. 

capital markets: 

• An effective, accurate, and transparent proxy system that ensures equality among 

shareholders is a fundamental element of healthy capital markets. 

• Efficient two-way corporate-investor communications are integral to such a proxy 

system. 

These principles will also ensure that public companies are provided a more modem foundation 

from which to focus valuable corporate resources on growth and innovation, instead of bearing 

the expense of an outdated proxy system. 

As referenced earlier, the SEC in 2010 issued a concept release seeking public comment on the 

U.S. proxy system and asking whether rule revisions should be considered to promote greater 

efficiency and transparency and enhance the accuracy and integrity ofthe shareholder vote. NIRI 

submitted a comment letter on this concept release, and although there have been no subsequent 

regulatory action to improve the proxy system, NIRI and other organizations continue to voice 

strong support for improved shareholder transparency and communications. 14 

To better understand these issues, it is helpful to review the aspects of our complex and outdated 

proxy system that prevent companies from knowing the identities of all of their shareholders. 

14 NIRI, "Comment Letter on the SEC's Concept Release on the U.S. Proxy Voting System" (Oct. 20, 2010), 

available at: httD:llwww.niri.orgiMain-Menu-CategorviadvocatelRegulatory-positionsJNIRI-Comment-Letter-reSEC-Proxy-Concept-Release-Oct -20 I O.aspx. 

9 
178 


81762.141

The Growing Disconnect Between Companies and Shareholders 

Over the past several decades, the percentage of public company shares held in "street name" --

which are held in the name of a broker, bank, or other financial intermediary rather than being 

"registered" in the name of the actual investor -- has grown dramatically from 25 percent to more 

than 80 percent, according to New York Stock Exchange estimates. 15 The benefit of this "street 

name" system is that it enables an efficient transfer of shares among owners and promotes 

greater liquidity in our capital markets. However, an important consequence is that it is virtually 

impossible for companies to know who owns their stock given this migration to shares held in 

street name (where the name of the investor is shielded from companies), combined with the 

growing use of alternative trading systems (also known as "dark pools"), and the decoupling of 

equity listings from their trading venues. 

A company's ability to communicate also is hindered by the "Objecting Beneficial Owner" 

(OBO) versus "Non-Objecting Beneficial Owner" (NOBO) shareholder classifications. Street 

name shareholders, as part of the process of establishing their brokerage accounts, have the 

option of allowing their contact information to be released to the company and receiving 

communications directly from the company (NOBO), or remaining anonymous (OBO). While 

companies can purchase NOBO information, this information takes several days to compile and 

quickly becomes out of date as shares are traded by investors each day. Consequently, it is both 

costly and ineffective for companies to communicate with these NOBO investors. These 

communication challenges negatively impact all shareholders, particularly "retail" (or individual 

investor) shareholders who hold almost 40 percent of street name shares, and have been voting 

less on proxy matters in recent years. 

As public companies' mandatory disclosures become more complex and voluminous, retail 

participation in the governance process may continue to decline. Current statistics indicate that 

only 14 percent of retail shareholder accounts vote their proxy ballots, according to Broadridge 

Financial Solutions. While anecdotal, there is a perception among retail shareholders with small 

or modest positions that their vote doesn't matter. Under the current system, a company's 

primary tools to encourage voter participation are general educational communications and the 

retention of a proxy solicitor, which is expensive and may not be effective. 

Public companies' communications to shareholders are further hampered by the SEC's outdated 

ownership disclosure rules for institutional investors. Current SEC rules (Section 13(f) generally 

require certain institutional investors to disclose share ownership positions only on a quarterly 

basis, with an exception made for those who petition the SEC to delay these disclosures on the 

basis of confidentiality. While not specifically designed to help companies identify their larger 

shareholders, Congress established this reporting regime in the 1970s to require certain larger 

investment managers to report their equity positions. The practical effect of this rule is that an 

investment manager may, for example, buy or sell shares on January I and not have to report that 

15 NYSE Euronext, "Recommendations of the Proxy Fee Advisory Committee to the New York Stock Excbange" 

(May 16,2012), available at: https:lluseguities.nyx.comlsites/useguities.nyx.comlfileslfinal pfac report.pdf 

10 
179 


81762.142

holding change until May 15, more than 19 weeks after the transaction. Many U.S. companies 

hold their annual meetings during this period, when shareholder communications are even more 

crucial. This quarterly reporting scheme was obviously established many years ago before 

technological advances improved the availability of information. This delayed reporting by 

investors further compounds the communication difficulties for public companies, given the 

trends toward greater shareholder anonymity (through street name registration) and the declining 

rates of retail voting. 

Communicating with and educating shareholders is a crucial part of encouraging retail investors 

to vote their shares. All parties to the proxy system - public companies, exchanges, brokerdealers, regulators, and service providers - playa role in educating investors. NIRI believes that 

timely, unbiased education will become increasingly important as companies have to provide 

even more complex and voluminous disclosures to comply with the Dodd-Frank Act and new 

SEC rules. 

Corporate Governance Trends Accelerate Need for Improvement 

Recent governance trends and regulatory changes (such as those mandated by the Dodd-Frank 

Act) give shareholders more say over executive compensation and other corporate governance 

matters. This shareholder empowerment further increases the need for regulators to address 

current barriers to corporate-shareholder communication. Public companies must be able to 

accurately identify and communicate directly with shareholders to ensure they can make 

informed decisions in the best interest of all shareholders. 

It is important to understand the potential ramifications from this increased shareholder 

influence. Among others, these activities include: 

Increased shareholder activism: Shareholder activists have more influence on corporate 

matters; some of these investors are encouraging proposals that advance their own selfinterest, to the detriment ofthe interests of all shareholders. 

• Growing influence of proxy advisory services: Institutional investors often base their 

voting decisions on the recommendations of proxy advisory firms. As mentioned 

previously, SEC officials, companies, and academics have raised concerns about the 

influence of these firms, the accuracy of their reports, and the potential conflicts of 

interest. 

Greater annual meeting costs: The cost of annual meetings will likely rise due to an 

increase in the expenses associated with preparing proxy materials, employing proxy 

solicitors to identifY and communicate with shareholders to meet quorum requirements, 

and other proxy voting costs. These administrative costs will reduce the amount that 

companies can spend to hire new employees and grow their businesses. 

As we move toward an environment of greater shareholder influence on corporate governance 

matters, the ability of companies to identify their investors, communicate directly with them, and 

encourage them to vote will remain a high priority, particularly in close vote situations or even 

simply to achieve quorum. 

11 
180 


81762.143

Recommended Proxy System and Shareholder Communications Reforms 

The current shareholder voting and communications system is more than 30 years old, and is a 

product of regulatory evolution rather than a thoughtful forward thinking design. NIRI, alone and 

together with other groups, has called for the following regulatory reforms to the current U.S. 

proxy and shareholder communications system: 

I. Improve Institutional Investor Equity Position (l3F) Reporting. The ownership reporting 

rules under the Section 13(f) reporting scheme should be amended to improve the 

timeliness of J3(f) reporting from 45 days after the end of the quarter to two days after 

the end of the quarter. Reporting rules should be strictly enforced with meaningful 

penalties for non-compliance. 

As part of Dodd-Frank, Congress directed the SEC to consider rules for a similar regime 

for short position disclosure every 30 days, so an evaluation of the entire 13(f) disclosure 

process follows logically. 

NIRI joined with the NYSE and the Society of Corporate Secretaries and Governance 

Professionals to provide the SEC with a comprehensive slate of related reforms in a Feb. 

I, 2013, letter. J6 More timely information is important because it will: 

a. Increase transparency about company ownership for the market overall. 

b. Improve the dialogue between companies and their investors. 

c. Help companies to better prepare for their annual meetings. 

d. Help address corporate governance concerns. 

e. Better correlate ownership reporting rules to other SEC-based reporting 

requirements. 

f. Recognize and capitalize on advances in technology that make timelier reporting 

possible. 

2. Enhance the U.S. Proxy System. Despite the SEC's laudable 2010 proxy system concept 

release, we have seen no action on any comments. NIRI submitted a comment letter with 

a comprehensive list of recommendations to improve several aspects of the U.S. proxy 

system, including those that will benefit corporate-shareholder communications. 

CONCLUSION 

NIRI is pleased to provide these comments as this Subcommittee considers issues concerning 

proxy advisory firms and improved shareholder communications. It is critical that we have an 

effective proxy system that is free from conflicts of interest and that allows for timely, efficient, 

and accurate shareholder communications. Equally important is a proxy system that is 

16 NIRl, NYSE Euronext, and Society of Corporate Secretaries, "Petition for Rulemaking Under Section l3(t) of the 

Securities Exchange Act of 1934" (Feb. 1,2013), available at: https:llwww.sec.gov/rules/petitions/20l3/petn4-

659.pdf. 

12 
181 


81762.144

transparent and accurate to ensure equality among shareholders. A modernized institutional 

disclosure system that allows companies to communicate effectively and efficiently with 

investors would increase public confidence in the integrity of the u.s. securities markets and 

potentially help pave the way for accelerated growth and innovation. 

As noted in the House Report for the Shareholder Communications Act of 1985: 

Informed shareholders are critical to the effective functioning of U.S. companies and to 

the confidence in the capital market as a whole. When an investor purchases common 

stock in a corporation, that individual also obtains the ability to participate in making 

certain major decisions affecting that corporation. Fundamental to this concept is the 

ability of the corporation to communicate with its shareholders. 

NIRI stands ready for further discussion regarding any of the suggestions or comments made in 

this testimony, or about the shareholder communication practices of investor relations 

professionals. 

13 
182 


81762.145

Statement 

of the 

U.S. Chamber 

of Commerce 

ON: "Examining the Market Power and Impact of Proxy Advisory Firms" 

TO: The House Subcommittee on Capital Markets and Government Sponsored 

Enterprises 

BY: Harvey Pitt 

DATE: June 5, 2013 

rhe Chamb~r's mission is to advance human ..::conomie, 

political and social system ba:-;cd on 

incentive, initiative, opportunity and responsibility. 
183 


81762.146

The U.S. Chamber of Commerce is the world's largest business federation 

representing the interests of more than 3 million businesses of all sizes, sectors, and 

regions, as well as state and local chambers and industry associations. The Chamber is 

dedicated to promoting, protecting, and defending America's free enterprise system. 

More than 96% of Chamber member companies have fewer than 100 

employees, and many of the nation's largest companies are also active members. We 

are therefore cognizant not only of the challenges facing smaller businesses, but also 

those facing the business community at large. 

Besides representing a cross-section of the American business community with 

respect to the number of employees, major classifications of American business--e.g., 

manufacturing, retailing, services, construction, wholesalers, and finance-are 

represented. The Chamber has membership in all 50 states. 

The Chamber's international reach is substantial as well. We believe that global 

interdependence provides opportunities, not threats. In addition to the American 

Chambers of Commerce abroad, an increasing number of our members engage in the 

export and import of both goods and services and have ongoing investment activities. 

The Chamber favors strengthened international competitiveness and opposes artificial 

U.S. and foreign barriers to international business. 

Positions on issues are developed by Chamber members serving on 

committees, subcommittees, councils, and task forces. Nearly 1,900 businesspeople 

participate in this process. 

2 
184 


81762.147

Chairman Garrett, Ranking Member Maloney, and Members of the Capital 

Markets and Government Sponsored Enterprises Subcommittee: 

Introduction 

I am pleased to participate in this Subconuruttee's important hearings, at your 

invitation, representing the U.S. Chamber of Commerce (Chamber), to discuss the 

extensive, but unfettered, influence over corporate governance currently being 

wielded by proxy advisory firms. 

By way of background, I am the founder and Chief Executive Officer of the 

global business consulting firm, Kalorama Partners, LLC, and its affiliated law firm, 

Kalorama Legal Services, PLLC (collectively, Kalorama).l Prior to founding 

Kalorama, as the Subcommittee is aware, I was privileged to serve the SEC in two 

separate tours of duty-first as a member of the SEC's Staff, from 1968-1978, 

culminating with my service, from 1975-1978, as SEC General Counsel, and second, 

as the SEC's 26th Chairman, from 2001-2003. In the nearly twenty-five years 

between my two governmental tours of duty, I was a senior partner in, and cochaired, an international corporate law finn. 

In the past forty-five years, I have served, variously, as a government policy 

maker and private sector advisor on a full panoply of matters affecting our capital and 

financial markets, publicly-held corporations, capital and flnancial market 

professionals and participants, and entities interested in, or affected by, the operations 

of this country's capital and financial markets. In my current role as CEO of the 

Kalorama firms, I am principally engaged in matters affecting corporate governance, 

regulatory policies and compliance-related issues. My professional experiences have 

provided me with an understanding of the ternary relationship between proxy 

advisory firms, investment portfolio manager organizations, and public companies, as 

well as the problematic corporate governance issues created by current practices of 

proxy advisory firms. 

Summary 

The allocation of capital to and governance of, public companies are inexorably 

intertwined with and vital catalysts for, our economic growth. Yet, disconcertingly, 

over the past decade and a half-largely as the result of governmental policies and 

1 .As the Committee has requested, I have attached (as Exhibit 1) a copy of my current resume, summarizing my 

education, experience and affiliations pertinent to the subject matter of this hearing. 

3 
185 


81762.148

administrative rulemaking-we have experienced a continuous and sizeable drop in 

the existing number of U.S. public companies.2 

Effective and transparent corporate governance systems that encourage 

meaningful shareholder communications are key if public companies are to thrive. 

Informed and transparent proxy advice can provide constructive support for effective 

corporate governance, but only if transparency exists throughout the process, and the 

advice being provided is direcdy correlated to, and solely motivated by, investor 

needs. These two essential components of effective proxy advice are currendy 

lacking, and have been for some time. 

For a number of years, the Chamber has expressed its long-standing concerns 

with the lack of transparency and accountability in, as well as the actual and potential 

conflicts of interest permeating, the operation of proxy advisory fIrms. 3 And, the 

Chamber has not been alone in voicing concerns with the operations of proxy 

advisory fums, both in the U.S. and globally.' The Chamber's concerns with certain 

practices and attributes of the most dominant members of the proxy advisory 

2 See e.g., D. Weild, E. Kim and L. Newport (Grant Thornton), THE TROUBLE Wi'm SMALL TICK SIZES, p. 16 (Sept. 

2012), available at 

http://www.gt.coffi fstaticflies! GTCOffi /Public%20companies%20and%20capital%20markets IT rouble Small Ticks.pd 

f (drop of over 43% of the number of public companies); iI. Stuart, MISSING: PUBLIC COMPANIES, CFO.com (Mar. 22, 

2011), http:/(www.cfo.com(artide.cfm(14563859 (loss of 42% of public companies listed on major U.S. exchanges). 

3 See, e.g., Chamber, Letter to SEC Chairman Mary Schapiro (May 30, 2012), attached as Exhibit 2 (discussing inherent 

conflict of Glass Lewis recommending a favorable vote on activist measures undertaken by its owner, the Ontario 

Teachers' Pension Plan); see also, Chamber. Letter re SEC Concept Release on the U.S. Proxy System. SEC File No. S7-

14-10 RlN 3235-.A.K43, attached as Exhibit 3. 

4 See generally J. Glassman & J. Verret, How TO FIX OUR BROKEN PROXY ADVISORY SYS'ITIM, Mercatus Center, George 

Mason University ("Mercatus Paper") (Apr. 16.2013), available at 

http://mercatus.org/sites(default(flles! Glassman ProJ>YildvisorySystem 04152013.pdf (highlighting significant 

concerns regarding the role of proxy advisory finns in the U ,So capital markets). The European Securities and Markets 

Authority ("ESMN') has focused substantial attention on proxy advisory firms in recent years. In March of2012, 

ESM..,.~ published «Discussion Paper: An Overview of the Proxy .Advisory Industry, Considerations on Possible Policy 

Options." available at http://www.esma.eu[Q!p.eu/svstem/filesf2Q12-212.pdf. More recendy, on February 19, 2013, 

ESM,\ published its "Final Report on The Proxy Advisor Industry," available at 

http://W\Y''w,esma.europa,eu!s.ystem/files/2013-84,pdf. These publications identify European regulatory concerns 

regarding the independence of proxy advisory firms. as well as the accuracy and reliability of the advice these £inns 

provide, as problems that warrant the fonnation of an industry-wide EU Code of Conduct to identify, disclose and 

manage conflicts of interest and otherwise enhance transparency and integrity in the proxy advice industry. In addition, 

on June 21, 2012, the Canadian Securities Administrators ("CSA") voiced its concerns regarding the proxy advisory 

industry. See Consultation Paper 25-401: Potential Regulation ofPro:x-y Advisory Firms, available at 

http://www.osc.gpv.on.ca/en/SecuritiesLawcsa2012062125-401pro..J.-advisory.f1rms.htm. and called for 

discussion aimed at resolving a variety of concerns, including (1) potential conflicts of interest; (2) lack of transparency; 

(3) potential inaccuracies and limited oppoffilnity for issuer engagement; (4) perceived corporate governance 

implications; and (5) extent of reliance by institutional investors. 

4 
186 


81762.149

industry5 are based on core tenets-transparency, accountability, and adherence to the 

letter and spirit of fiduciary duties-that are critical for, but frequently absent from, 

the practices of the dominant companies comprising this industry. 

The conflicts of interest that compromise the efforts of the dominant proxy 

advisory firms pose a glaring hazard to shareholders, because proxy advisory firms 

have exercised disproportionate influence over the proxies cast by some institutional 

investors on behalf of these institutions' investors, often at the same time these proxy 

advisory finns receive compensation from the same public companies about which 

they are recommending voting positions to their investment portfolio management 

organization clients. 

Proxy advisory finns are unregulated; more significantly, they operate without 

any applicable standards--either externally-imposed or self-imposed-and do not 

formally subscribe to well-defined ethical precepts, while cavalierly rejecting private 

sector requests for transparency in the formulation of their proxy advice, as well as 

increased accountability for the recommendations they make. This lack of any 

operable framework for such a powerful presence on economic growth and corporate 

governance is unprecedented in our society.6 

Moreover, regulatory bodies have observed the growing impact of proxy 

advisory firms on U.S. corporate governance, combined with the lack of any coherent 

articulation of standards to which these firms adhere, but have not spoken 

definitively-in any official pronouncement-about the need for standards to govern 

the activities of proxy advisory firms, the importance of assuring fidelity to fiduciary 

principles by these entities, or the troublesome and pervasive conflicts of interest that 

encumber the dominant proxy advisory firms and plague recommendations they 

make.7 

, Two proxy advisory firms-Institutional Shareholder Services Inc. ("ISS') and Glass Lewis & Co., LLC ("Glass 

Lewis")-together comprise about 9r/o of the proxy advisory business. See 1-1ercatus Paper, supra n. 4, at p. 8 (noting 

that ISS and Glass lewis possess, respectively, a 61 percent and 36 percent market share of the proxy advisory business). 

Moreover, it has been estimated that ISS and Glass Lewis effectively CCcontrol" 38% of the institutional shareholders' 

vote, see Ertimur, Yonca, Ferri, Fabrizio and Oesch, David, SHAREHOLDER VOTES AND PROXY .ADVISORS: EVIDENCE 

FROM SAY ON PAY. 7th I\nnual Conference on Empirical Legal Studies Paper (Feb. 25. 2013), available at 

http://papers.ssrn.com/so13/papers.cfm)abstract id-2019239. 

6 Indeed, even the press, which is subject to First ... -\mendment protections against the government's abridgement of the 

right of free speech, has subjected itself to both industry standards and individually imposed ethical and transparency 

requirements. See, e.g., The Society of Professional Journalists Code of Ethics, available at 

http·!!www.spj.org/ethicscode.asp (instructing journalists to "avoid conflicts of interest, real or perceived; Remain free 

of associations and activities that may compromise integrity or damage credibility" and to "disclose unavoidable 

conflicts"). 

7 The Securities and Exchange Commission C'SEC")-a logical agency to provide some guidance and direction for 

proxy advisory firms-has noted the importance of proxy advisory firms and promised to address the issues 

5 
187 


81762.150

To address this lack of articulated core principles and best practices, in March 

of this year, the Chamber published its Best Practices and Core Prindplesfor the 

Development, Dispensation and Receipt of Proxy Advice (Chamber Principles), 8 a project on 

which I was privileged to participate. At a minimum, the Chamber Primiples provide a 

crucial predicate for a private sector dialogue on these issues and, more broadly, 

provide constructive guidance for collaborative private sector efforts to repair this 

broken system. 

Background 

As the Subcommittee is well aware, investors invest capital in public companies 

with the expectation they will receive a positive return on their investment and be 

entitled, under applicable state corporation law and fundamental corporate 

foundational documents--charters and by-laws-to elect directors and to approve or 

disapprove proposals relating to the governance of the corporations in which they 

have invested.9 Day-to-day management of public companies is left-as it must bewith company management, overseen by the company's board of directors. 

Individual--or so-called "retail" -shareholders have the right to vote for 

directors and on shareholder proposals, based on the number of shares they own, but 

surrounding their activities. See SEC Concept Release on the U.S. Proxy System at 105·26 ([uly 14, 2010), available at 

http://www.sec.gov/rules/concept/2010/34-6249S.pdf (discussing "concerns about the role of proxy advir;.0f}T 

firms" --specifically "conflicts of interest" and «lack of accuracy and transparency in formulating voting 

recommendations"). And it has indicated that proxy advisory fIrms will be part of its regulatOr\r agenda see SEC Agency 

Financial Report for FY 2012 at 31, available at http://www.sec.gov/abo\lt/secparlsecafr2012.pdf#2012re\~ew (noting 

that, Hin FY 2013, the SEC will develop recommendations for an interpretive release addressing issues raised in the July, 

2010 'Proxy Plumbing' concept release about proxy advisory finns"); E. Chasan, SEC PLANS NEW GUIDANCE ON 

PROXY ADVISERS, CFO Journal ([une 7, 2012) (stating that the then·Director of SEC's Division of Corporation 

Finance, said that, after the 2012 proxy season, .... the SEC staff will look at issuing fresh 'interpretive guidance' about the 

fiduciary duties investors have in assessing the information they get from proxy adv:lsers and how those services handle 

conflicts of interest"). http://blogs.wsj.com/cfo!2012!06/07 Isec-plans-new-guidat1ce-on-proxy-advisers/, but has not 

fulfilled its stated intentions. Individual SEC members have spoken out about the lack of principled and conflict-free 

behavior by proxy advisory firms. See, {I,g., SEC Commissioner Daniel M. Gallagher, Remarks at 12th European 

Corporate Governance Law Conference (1\fay 17, 2013), available at 

http://www.sec.gov/news/spcech!2013!spch051713dmg.htm; SEC Commissioner Troy A. Paredes, Remarks at 

Society of Corporate Secretaries & Governance Professionals, 66th National Conference on «The Shape of Things to 

Come" ([uly 13,2012), available at http://www.sec.gov!news/speech!20121spch071312tap.htm#P39 14566. 

8 .. A copy of the Chamber Pn'llcipks is attached as Exhibit 4. 

9 Until 2002, and the passage of the Sarbanes·Oxley Act of 2002, Pub.L. 107-204, 116 Stat. 745, the laws of a 

corporation's state of incorporation governed the substantive rights of shareholders, while federal law governed the 

disclosures required when public companies solicit shareholder votes, and the methodology by which those votes are 

solicited. Sarbanes-Oxley's encroachment on states' substantive provision of shareholder rights was considerably 

expanded by the passage of the Dodd·Frank Wall Street Reform and Consumer Protection Act, Pub.L. 111-203, H.R. 

4173 ("Dodd-Frank Act"). !vfany corporate governance issues are presented to public company shareholders in the 

form of so-called shareholder proposals, and are governed by SEC Rule 14a-8(d), 17 C.F.R. §240.14a-8( d). 

6 
188 


81762.151

are not obligated to do so. For a variety of reasons, retail shareholder participation in 

director elections and shareholder proposals has declined markedly over the years, in 

some cases constituting no more than five percent of the total votes held by retail . 10 IDvestors. 

In contrast, institutional investors,11 or those who pool funds of similarlysituated individuals and invest those funds with the expectation of producing a 

positive return for the investors whose funds they manage, are legally obligated to 

vote shares under their management in director elections and \vith respect to 

shareholder proposals. Some institutional investors-SEe-registered investment 

advisers-are specifically required to promulgate policies describing how they will 

vote the shares of public companies subject to their management and, a considerable 

period of time after votes have been cast, must disclose how they actually voted those 

shares.12 

Institutional investors and institutional portfolio managers routinely invest in 

the equity securities of hundreds, if not thousands, of public companies. Institutional 

portfolio managers owe fiduciary duties of loyalty and care to the investors whose 

assets they manage, with respect to all activities undertaken on behalf of their clients, 

including exercising proxies for the portfolio securities they manage. The requisite 

due diligence to fulfill the fiduciary duties associated with proxy voting-learning and 

understanding the issues around director elections and shareholder proposals, and 

determining the voting position that will best further the interests of their investorsis complex, costly, and burdensome. 

Thus, investment portfolio managers that exercise delegated authority to vote 

proxies involving public companies held in the investment portfolios they manage, 

often retain proxy advisory firms to assist them in appropriately exercising their 

important voting responsibilities and ascertaining how best to satisfy their fiduciary 

obligations. Proxy advisory fitms provide that assistance in various forms, including 

10 See, e,g" F, Saccone, E-PROx'Y REFORM, AcrrvIsM, ,,"'iD THE DECUNE IN RETAIL SHAREHOLDER VOnNG, The 

Conference Board Directors Notes No, DN-021 at 4 (Dec. 26, 2010), available at 

bttp:!lpaper<,ssm,com/soI3/papers.cfm?abstract id=1731362 (quoting a 2008 speech by then-SEC Commissioner Paul 

Atkins that noted the number of retail accounts voting, where e-proxy was used, was 5.7%, and citing to data. from 2009 

and 2010 demonstrating that those retail voting accounts that received notice of a proxy vote (instead of the full proxy 

materials) voted between 4 and 5 % of the time. 

11 Instirutional investors include insurance co'mpanies; private pension funds; corporate, state, municipal and labor union 

pension funds; commercial banks, educational and other endowment funds, trust funds; collective investment funds; 

trust funds; hedge funds. SEC-registered investment advisers, private equity funds; state-registered investment advisers; 

venture capital funds; and mutual funds. 

12 See SEC Investment Advisers Act Rule 206(4)-6, 17 C.P,R. §80b-206(4)-6. 

7 
189 


81762.152

analyzing voting issues and! or providing specific voting recommendations; these 

firms frequently manage all aspects of the proxy process for their investment portfolio 

manager clients. Specifically, proxy advisory finns may: 

• Research portfolio companies, including issues of relevance to director 

elections and shareholder proposals; 

• Provide voting recommendations; and 

• Cast actual votes for their clients. 

Investment portfolio managers utilize one or all of these proxy advisory 

se!Vlces. 

Proxy Advisory Firms 

Two firms-ISS and Glass Lewis~ominate the proxy advisory industry. 

Together, they control 97% of the proxy advice market. 13 More significantly, it has 

recently been estimated that ISS and Glass Lewis "control" 38% of the shareholder 

vote. 14 This means that, an identical ISS and Glass Lewis recommendation \ViU move 

38% of the shareholder vote, absent a vocal campaign against that position. This is an 

obvious reflection of the fact that ISS' and Glass Lewis' institutional clients frequently 

follow those firms' recommendations automatically. Unfortunately, advice provided 

by ISS and Glass Lewis is not tailored to the interests of the shareholders of each 

firm's investment portfolio manager clients, nor is it formulated with any 

consideration of the stated policies and purposes of the portfolios housing the equity 

securities to whicl1 the recommendations relate. 

Given the huge percentage of the vote likely controlled by ISS and Glass Lewis, 

the failure of an issuer to comply with those firms' preferred policies saddles issuers 

with a large number of negative votes before voting has even begun. Proxy advisors, 

therefore, also can affect valuations and the ultimate outcomes of contests and 

specific transactional matters. As a result, ISS and GJass Lewis have become the 

de facto standard setters for corporate governance policies in the U.S. 

13 See n. 5, supra. There are other firms) such as Egan-Jones Proxy Services Jnc. ("Egan Jones"), that provide a full array 

of proxy advisory services, as well as companies that provide research only, such as 11anifest Information Services Ltd.,. 

although these firms have neglit,nble market presence. 

1·1 ISS reportedly influences 24.7{% of the votes cast, and Glass Lewis reportedly influences 12.9% of the shareholder 

vote. See n. 5, Iupra. 

8 
190 


81762.153

A recent example of the significant power wielded by these two finns is worth 

highlighting for the Subcommittee. The Dodd-Frank Wall Street Refonn and 

Consumer Protection Act (Dodd-Frank Act) includes a provision requiring 

shareholders of public companies to be given a non-binding, advisory, vote on 

executive compensation, otherwise known as "Say on Pay."15 In doing so, Congress 

explicitly provided that shareholders should determine whether the frequency of such 

"Say on Pay" votes should occur at intervals of one, two or three years. 

Putting to one side whether Congress should have mandated shareholder votes 

on executive compensation, this Dodd Frank Act provision's structure permitted 

shareholders to determine the frequency of such votes best fitting each public 

company's needs, affording them the flexibility to match the shareholders' advisory 

vote with the tenn of the company's compensation packages, nonnally three years. 

ISS and Glass Lewis announced an ironclad recommendation that, in all instances the 

frequency of "Say on Pay" votes should be yearly. The advisory finns did this without 

any evidence whether a particular frequency of voting cycle would provide better 

shareholder return than a different cycle, or whether differences among companies 

might warrant a frequency cycle longer than one year. 

A frequency cycle of one year means that institutional investors must reevaluate their portfolio companies' compensation practices every year, even if 

particular portfolio companies fix their executives' compensation on a three-year 

review cycle. Apart from the utter waste and meaninglessness fostered by the ironclad ISS/Glass Lew"is position on this issue, the one year cycle they vigorously 

recommended, by definition, means that most, if not all, of the two firms' institutional 

portfolio manager clients will need to retain ISS and Glass Lewis to fulfill their 

obligation to vote yearly on executive compensation. 

Interestingly, there was no disclosure by ISS or Glass Lewis of their conflict of 

interest in recommending an iron-clad one-year voting cycle on executive 

compensation for every single public company. This lack of disclosure could have 

occurred for one of two reasons--either one or both finns were totally insensitive to 

their conflict of interest in recommending an annual vote on this issue, or one or both 

were aware of the conflict but decided not to disclose it. Either way, their failure to 

disclose the conflict inherent in their recommendation is itself damning evidence of 

the need for even minimal standards to govern how proxy advisory FInns render their 

servlces. 

1; Dodd-Frank Act §951 (adding new §14A(a) to the Securities Exchange Act of 1934). 

9 
191 


81762.154

Of course, by reconunending a one-year frequency vote, ISS and Glass Lewis 

have likely procured additional advisory business yearly. Moreover, in making a onesize-fits all reconunendation that a "Say on Pay" vote must be held annually for all 

companies, ISS and Glass Lewis thwarted the public policy determination Congress 

made to permit shareholders to tailor the frequency of this vote to the circumstances 

of each company. It is not often that any industry in our society has the ability, singlehandedly, to override Congressional policy. More importantly, the ISS/Glass Lewis 

reconunendations effectively eviscerated the ability of corporate shareholders to 

debate and decide the issue. 

This was all done without any study or empirical evidence on how the 

frequency of "Say on Pay" votes affects shareholder values, either in general or vis-avis specific companies. In fact, a recent study by the Center for Corporate 

Governance at Stanford University's Graduate School of Business concluded that 

proxy advisory firms' preferred compensation policies actually have a negative effect on 

share value. 16 Nevertheless, because of ISS' and Glass Lewis' reconunendations, 

Dodd-Frank Act was rewritten to provide for a universal one year "Say on Pay" 

votesY 

Despite this market dominance and influence on corporate governance 

policies, the proxy advisory industry has been beset by problems, enmeshed in 

frequent conflicts of interest and generally shown great resistance to standards that 

might improve their performance and avoid eventual governmental oversight 18 The 

lack of transparency and accountability of proxy advisory finns is a troubling trend 

that undermines confidence in, and stalls progress of, strong corporate governance. 

The role of proxy advice has become increasingly important as the number and 

complexity of issues on proxy ballots has grown exponentially. And yet, proxy 

advisors have not taken steps to ensure their voting reconunendations are developed 

based on clear, objective, and empirically-based corporate governance standards to 

help management and investors evaluate and improve corporate governance as a 

means of increasing shareholder value. 

16 D. Larker, A McCall and G. Ormazabal, THE ECONOMIC CONSEQUENCES OF PROXY ADVISOR SAY-ON-PAY 

VOTING POLICIES, Stanford Graduate School of Business Research Paper No. 2105 (July 5, 2012), available at 

http://papers.ssm.com/so13/papers.cfm?abstract id-2101453. 

17 In theory, individual public companies could have waged campaigns against the ISS/Glass Lewis position of a 

universal one-year frequency cycle for Say on Pay votes, but the costs of waging such a campaign would have been 

prohibitive. especially given the likelihood that at least 38% of the votes were initially aligned against such a campaign. 

\Vhilc Congress does not subject its legislative efforts to a meaningful cost-benefit analysis, t.his is one area where the 

Country could have benefitted from such an analysis. 

18 See ISS Response to the U.S. Chamber of Commerce's Guidelines for Proxy Advisory Fiems (Mar. 21, 2013), available 

at http://www.issgovemance.com/press /issresponsechamberofcommerce. 

10 
192 


81762.155

While ISS and Glass Lewis purport to be striving for transparency and 

accountability in the corporate governance of others, these flnns show no inclination 

toward applying to themselves the same standards they recommend others follow. 

Transparency and accountability are missing vis-a.-vis the way ISS and Glass Lewis 

develop voting policies and recommendations. Thus, for example, although ISS is a 

defacto governance standard setter for corporate America, akin to the accounting 

pronouncements of the Financial Accounting Standards Board, ISS does not follow 

even the more mundane and ministerial general procedures or guidelines all legitimate 

and non-self-anointed private sector and governmental standard setters follow when 

ISS changes its annual voting policies, such as a prmriding a public comment and 

notice period. Without adequate procedures, it is unclear who (and what) really drive 

ISS' policy updates. Additionally, ISS' almost simultaneous release of voting policies 

with the closure of an unnaturally short comment period call into question whether 

letters submitted to ISS by public stakeholders are understood, considered, or even 

read. 

Similarly troubling, ISS may afford larger companies twenty-four hours to 

review and respond to company-specific recommendations, but other companies are 

provided absolutely no opportunity to review or respond to these company-specific 

recommendations whatsoever.19 There is no basis for this discriminatory practice on 

ISS' part. Indeed, it could be argued that most of its clients have the capacity to ferret 

out information about the largest public companies by themselves, whereas very 

few-if any-would have the ability to flnd out much about smaller companies that 

ISS totally excludes from any participation in ISS' fact-finding and formulation of 

recommenda tions. 20 

Glass Lewis, in turn, is a "black box" that docs not pennit any type of input or 

dialogue into its fact-finding and recommendation-formulation processes. Nor docs 

Glass Lewis conduct a general public review of its policy positions and updates. 

19 To follow-up on an active dialogue that the Chamber had fostered with corporate secretaries and ISS to correct some 

of these flaws~ the Chamber in 2010 wrote to ISS and the SEC with a proposal to inject ttanspa:rency and accountability 

into this system by creating Administrative Procedure .. A.ct-like processes for voting policies and recommendations. See 

memorandum from U.S. Chamber of Commerce to ISS (",ugust 4, 2010), available at 

http://www.sec.ggv/commcnts/s7-14.10/s71410-268.pdf.This would have allowed for an open dialogue in which all 

stakeholders could have participated, and would have better informed ISS of circumstances material to the interests of 

its clients. To date ISS has not acted or commented on these recommendations. 

20 One could speculate that the reason ISS denies smaller public companies any opportunity to comment is that such 

smaller firms are less likely than larger companies to become ISS clients. Another speculative rationale for it approach 

may be that ISS does not devote adequate resources to researching smaller public companies, perhaps utilizing generic 

policy positions to formulate its recommendations; if that were the case, permitting comment: by smaller companies 

might consume energies and resourCes ISS is unwilling to expend in formulating its positions ...vith respect to such 

smaller-sized companies. 

11 
193 


81762.156

Rather, for most observers, the first glimpse of Glass Lewis' annual policy updates 

occurs qfrerGlass Lewis' policies have already been finalized. It is of enormous 

concern as well that Glass Lewis does not provide public companies with the chance 

to review and respond to recommendations. 

The stakes for many public companies are quite high--director elections, major 

corporate transactions and significant shareholder proposals all can have an enormous 

impact on the companies confronting those issues and, even more importandy, can 

have a profound effect on the shareholders who have invested in those companies. 

By refusing to provide any input whatsoever into its positions, Glass Le,vis appears 

affirmatively to embrace the notion that it would rather base its position on factual 

errors than take the time to ensure that its positions are based on factually correct 

premises. No other industry-whether its members are government regulated or 

merely faithful to industry best practices--could survive such a cavalier disrespect for 

factual accuracy, fairness and transparency. 

ISS and Glass Lewis also are subject to potential conflicts of interest that 

impair the reliability, fairness and accuracy of their recommendations. ISS operates a 

consulting division that provides advice to the same public companies about which 

ISS opines and influences institutional votes, including selling advice on the ways 

these companies can achieve better ISS corporate governance ratings. In fact, ISS' 

ownership of this consulting arm-accepting fees from both the institutional 

investors who receive their voting advice as well as from the public companies that 

are the subject of their voting advice-has been a focal point for criticism of the 

conflicts of interest inherent in this business model, including criticism from the 

firm's former CEO.21 

It should also be mentioned that ISS s, when making recommendations on a 

shareholder proposal of competing slates of directors, do not disclose if the 

proponent of the proposal or slate is a client.22 

Notably, just two weeks ago, ISS setded SEC charges that ISS' failure to 

establish or enforce written policies and procedures enabled an ISS employee to 

provide information to a proxy solicitor concerning how more than 100 of ISS' 

institutional shareholder advisory clients were voting their proxy ballots. Without 

admitting or denying the allegations, the finn agreed to pay a $300,000 fine and to 

21 M. Murphy, "Nell Minow Says Governance Has a Long Way to Go," CFO Joumill (June 26, 2012), available at 

http://blogs.wsj.com/cfo/2012/06/26/nell-minow-says-ggvernance-has-a-long-ways-togo/?mod-wsjpro hps cforeport. 

22 See Glass Lewis Conilict of Interest Statement, available at http://www.glasslewis.com/about-glass-Iewis/disclosureof-conflict/. 

12 
194 


81762.157

engage an independent compliance consultant to review its supervisory and 

compliance policies and procedures.23 Although virtually all business enterprises have 

policies regarding the handling of the type of information that the ISS employee 

misused, ISS' failure to adopt such procedures and policies is consistent with its longstanding opposition to developing reasonable policies and procedures regarding any 

aspect of its proxy advisory activities. 

It is also significant that Glass Lewis is owned by an activist institutional 

investor-the Ontario Teachers' Pension Plan-and yet Glass Lewis takes positions 

on the precise issues its parent company forcefully advocates for public U.S. 

companies. The Chamber has written the SEC on several occasions regarding the 

apparent conflict of interest presented by the issuance of Glass Lewis 

recommendations in favor of activist measures undertaken by its owner.24 To date, 

however, the SEC apparently has taken no action in response to these events, and has 

not provided the Chamber with a substantive response. The Chamber also wrote to 

the Department of Labor (DOL), asking that it also look into these matters, as the 

advice ERISA pension funds receive must be linked to shareholder return and free of 

potential conflicts of interest.25 To date, the DOL apparently has taken no action in 

response to these events, and also has not provided the Chamber with a substantive 

response. 

Concerns also have been raised that certain politically-motivated clients of both 

ISS and Glass Lewis disproportionately influence those firms' vote recommendations, 

and the policies they are based on, to advance a political agenda that is not geared 

towards improving shareholder return.26 This is particularly troublesome, given the 

recent rise in the number of shareholder proposals related to political spending 

disclosures. The concern here is that certain politically-motivated shareholders may 

be attempting to use corporate governance processes to silence corporate speech, 

rather than to increase shareholder returns, and ISS and Glass Lewis may be 

23 In the Matt" if Institutional S harthold" SmiteS Inc., Inv .• ~dvisers Act Rei. No. 3611 q,lay 23, 2013), available at 

http://www.sec.gov/litigation/admin/2013/ia.3611.pdf. 

24 See Letter from Tom Quaadman to SEC Chairman Mary Schapiro (May 30, 2012), available at 

http://www.centerforcapitalmarkets.com/v.:p·content/uploads/2010/04/2QI2·5.30·Glass·Lewis.letter.release.pdfLetter from Tom Quaadillan to SEC Chairman Marv Schapiro (Sept. 12 2011) available at 

http:((w",w.sec.gov!comments/s7.14.10/s71410.301.pdf. 

25 See Letter from Tom Quaadman to Assistant Secretary of Laber Phyllis Boni (June 25, 2012), available at 

http://www.centerforcapita!markets.com/wp·content I uploads 1?01 Q I 04/2012·6. 25· DOL· Letter ·re·GI,,· Lewis· 

Canadian.Pacific.pdf. 

26 See J. Glassman & J. Verret, FIXING THE BROKE" PROXY SYSTEM, Bloomberg (Apr. 23, 2013), available at 

http://www.bloomberg.com/news/2013.04.23/pr0''Y·fi.rm·debacle·can·be·reversed.html. 

13 
195 


81762.158

affIrmatively embracing those efforts, rather than focusing their efforts on improving 

shareholder results. 

Additionally, serious questions have been raised about the quality and rigor of 

the research undertaken by proxy advisory fIrms. For instance, ISS apparently 

employs 180 analysts to evaluate 250,000 issues, spread over thousands of companies, 

within a six-month period known as proxy season.27 As noted above, "Say on Pay" 

votes have become an annual event for U.S. public companies, and thus an annual 

recommendation for proxy advisory FInns. In forming its "Say on Pay" 

recommendations, ISS compares companies' compensation levels against groups of 

companies that ISS deems to be the comparable. 

But, ISS does not disclose how it develops these so-called "peer groups," or the 

criteria on which these "peer groups" are predicated. Not surprisingly, these "peer 

groups" have generated heavy criticism due to the inconsistent standards utilized to 

form them, and the inaccurate bases on which these so-called "peer groups" are 

predicated.2B This criticism is not without legitimacy, as hotels have found their ISSselected "peers" to include automotive-parts companies and holding companies 

involved in numerous business segments.29 Indeed, during the last full proxy season, 

ISS's poor "peer group" formulations, combined with its unwillingness to amend 

poorly constructed and unrepresentative "peer groups," prompted a number of 

companies to take the extraordinary step of filing additional proxy materials following 

receipt of ISS's report to educate investors on the inappropriateness of the "peer 

group" chosen by ISS.30 

These issues with proxy advisory fIrms have set back the cause of good 

corporate governance and, if unaddressed, may have the potential to reverse otherwise 

27 Chamber Principles at 3 .. available at http://www.centerforcapitalrnarkets.com/wp-content/uploads/2010/04/BestPractices-and-Core-Principles-for-Proxy-Advisors.pdf. 

28 See, e.g., P. Park, CORPORATE GOVERNANCE WATCH: COMPANIES CRITICIZE ISS OVER PEER GROUP SELECnON 

METHODOLOGY, Business Law Currents, Thomson Reuters Westlaw (May 17, 2013), 

http://currents.westlawbusiness.com/ J\rticle.aspx?id =444afa88-6898-4913-bece-82332 80a2390&cid=&src=&sp=. 

29 See E. Chasan, WATCHDOG CHALLENGED OVER PAY BENCHMARKS, CFO Journal (May 8, 2012) available at 

http://blogs.wsj.com/cfo/2012l0S/08/watchdog-chaUengtd-over-pay-benchmarks/; Jee also See, e.g., P. Park, 

CORPORATE GOVERNANCE WATCH: CO~n'ANIES CRI11CIZE ISS OVER PEER GROUP SELECTION METHODOLOGY, supra n. 

29 (criticizing ISS' selection of "peer groups," such as a coal company and transportation company as peers for an oil 

and gas storage company); S. Quinlivan, ISS' PEER GROUPS BEGIN TO SPUR COMPl.AINTS, Making Sense of DoddFrank, DODD-FRANK.COM (!VIar. 23, 2012), available at http://dodd-frankeom/iss%E2%80%99-peer-groupsbegln-tQ-spur-complaints! 

30 See e.g.,J. Barrall, PROA>' SEASON 2012: ThE ROLE OF SUPPLEMEN'TAL PROXY SOLICITATIONS, Los Angeles & San 

Francisco Daily Journal (June 18,2012), available from http://www.lw.com/thoughtLeadership/proxy-season-2012-

supplemcntal-pro:x-y-solicitations. 

14 
196 


81762.159

positive advances in corporate governance, such as increased communications and the 

empowetnlent of directors and shareholders that have occurred over the past few 

decades. 

Relevant Factors 

Rule 206(4)-6 

In 2003, while I was the Chairman of the SEC, the Commission adopted 

Investment Advisers Act Rule 206(4)-6, requiring registered investment portfolio 

management organizations to adopt and disclose policies regarding how portfolio 

managers would vote the securities in their various managed portfolios. The 

Commission specifically noted that an investment portfolio manager's fiduciary duties 

encompassed the voting of portfolio securities. In so doing, the SEC recognized that 

investment advisers, either direcdy or indirecdy through affiliates, may have 

relationships with issuers that could potentially influence the decision-making of the 

investment adviser in exercising client proxy votes, thereby compromising the 

adviser's independence and violating the adviser's fiduciary duty to act in the best 

interests of its clients. 

Notably, the SEC's only mention in its release proposing the adoption of Rule 

206(4)-6 of proxy advisory firms was indirect, and was made in reference to the 

investment adviser policies, indicating that 

[t]he extent to which the adviser relies on the advice of third parties or 

delegates to committees should also ordinarily be covered by the 

policies.31 

Consistent with the extremely limited attention in the Rule 206(4)-6 Proposing 

Release dedicated to proxy advisory firms, the Commission's release announcing the 

adoption of the Rule included only a single sentence referencing an investment 

adviser's use of a proxy advisory firm; it noted that 

[a]n adviser could demonstrate that [its] vote was not a product of a 

conflict of interest if it voted client securities, in accordance with a pre31 Proxy Voting by Investment Advisers Proposed Rule at II.A.2. Rei. No. IA-2059; File No. 57-38-02 (Sept. 20, 2002), 

available at http://www.sec.gov/rules/proposed/ia-2059.htm. 

15 
197 


81762.160

determined policy, based upon the recommendations of an independent 

third party.32 

The "conflict of interest" referred to was the possible conflict between an 

investment adviser and a third party-to wit, the focus of Rule 206(4)-6 more 

generally-not to a possible conflict between the third party and the corporate issuer. 

Indeed, at the time, I discussed the catalyst for this rule being potential conflicts of 

interest that mutual fund investment advisers face in voting their shares. Specifically, 

I explained that, 

because the securities are held for the benefit of the investors, they 

deserve to know d1e fund's proxy voting policies and whether [those 

policies] were in fact followed. Many wield voting power in the face of 

conflicts; they may cast votes furthering their own interests rather than 

those for whom they vote.33 

The Stafrs "No-Action" Letters 

After my tenure as Chairman ended, in 2004, the SEC Staff profoundly 

changed the requirements of Rule 206(4)-6 by issuing a "no-action letter" to EganJones (Egan-Jones No-Action Letter) on May 27, 2004/4 as supplemented by a 

subsequent "no-action letter" issued to ISS (ISS No-Action Letter) on September 15, 

2004 (collectively, No-Action Letters).35 As a practical matter, the No-Action Letters 

had the legal effect of pennitting registered investment advisers to rely exclusively on 

a proxy advisory finn's generaipolicies and procedures pertaining to conflicts of 

interest-as opposed to any specific conflicts a proxy advisory finn might have with 

respect to a particular issue or a particular company about which the proxy advisory 

firm might make a recommendation-to detennine if the proxy advisory finn was 

independent and could be relied upon to cast a vote for the investment adviser, 

without the adviser being deemed to have violated Rule 206(4)-2 of the Investment 

Advisers Act or any other provision of the federal securities laws. 

"Proxy Voting by Investment Advisers Final Rule at IL\.2.b., 17 CFR 275, ReI. No. 1.\.2106, File No. S7-38-02 (Mar. 

10,2003), available at htt12:llwww.sec.gov/rules/fmaIlia-2106.htm. 

33 Chairman Hanrey L. Pitt, SEC, "Speech by SEC Chairman: Remarks at the Commission Open Meering," Gan. 23, 

2003), http://www.sec.gov/news/speech/spchOI2303hlp.htm. 

34 Egan-Jones Proxy Services, SEC No-Action Letter (May 27, 2004), avaihbk at 

http://www.sec.gov/divisjoQs/investment/noaction/eganOS2704.htm. 

35 Institutional Shareholder Services, Inc., SEC No-Action Letter (Sept. 15, 2004), avai/abk at 

http://'\l.''\vw.sec.gov/divisions/investrnent Inoaccion Iiss091504.htm. 

16 
198 


81762.161

In its Egan-Jones No-Action Letter, the SEC Staff indicated that 

recommendations of a third party proxy advisory firm that is independent of an 

investment adviser "may cleanse the vote" cast by an investment adviser of any 

conflict the adviser otherwise might have. In addition, the Staff announced, as a 

general rule that, "the mere fact that the proxy advisory firm provides advice on 

corporate governance issues and receives compensation from the Issuer for these 

services generally would not affect the firm's independence from an investment 

adviser." The Staff noted, however, that an investment adviser "should take 

reasonable steps to verify that the third party is in fact independent of the adviser 

based on all of the relevant facts and circumstances." 

Soon thereafter, ISS sought clarification of the Egan-Jones No-Action Letter 

by asking if an investment adviser could satisfY the independence requirement of Rule 

206(4)-6 if it "determines the impartiality of a proxy voting fl111l based on the firm's 

overall policies and procedures rather than on an examination of the proxy voting 

fl111l's specific relationships with individual issuers" (emphases supplied). The 

Commission's staff responded to ISS by providing the requested assurances that an 

investment adviser may, without violating Rule 206(4)-6, rely exclusively on a proxy 

advisory fl111l's general conflict policies and procedures in determining the fl111l's 

impartiality to make recommendations. Departing from the Staffs Egan-Jones letter, 

the SEC Staff advised ISS that "a case-by-case evaluation of a proxy voting fl111l's 

potential conflicts" is not necessary, and that an investment adviser could determine 

the independence of a proxy advisory firm "based on the firm's conflict procedures," 

without more.36 

The No-Action Letters effectively instruct that, if investment advisers rely on 

recommendations of proxy advisory fl111ls, they need not concern themselves about 

conflicts of interests regarding the advisory fl111ls' specific relationships with issuers 

about whom the proxy advisory fl111ls are making recommendations. While the 

Chamber is reviewing these issues in relation to proxy advisory firms, in other 

contexts the Chamber has raised concerns regarding Staff developed policies that 

have not been not approved by the SEC Commissioners, nor been vetted through 

normal Administrative Procedure Act processes, including a cost benefit analysis. 

36 The No-Action Letters are not typical SEC no-action letters, which the SEC has generally limited to informal guidance 

on particular circumstances and specific addressees. The SEC describes its typical no-action letter as a document "in 

which an authorized staff official indicates that the staff "'~ not recommend any enforcement action to the Commission 

if the proposed transaction described in the incoming correspondence is consummated." SEC ReI. No. 33-6253, SEC 

Docket Vol. 21, No.5 at 320-21 n.2 (Nov. 11, 1980). These letters contain no disclaimer that the Letters' contents are 

limited to the specific facts and circumstances presented in the requesting letters. 

17 
199 


81762.162

Chamber Principles 

Given this background, and the current state of the proxy advisory industry, 

the Chamber believed it prudent to develop a set of core principles and best practices 

to serve as a basis for a dialogue among proxy advisory fmus, the public companies 

about which they report, and investment portfolio manager organizations to which 

proxy advisory [mus report. I was privileged to be an active participant in the 

development of the core principles and best practices the Chamber sought to 

memorialize. The ultimate goal of this effort is the development of a universally 

embraced private-sector system that brings transparency and accountability to the 

activities of proxy advisory [mus, fosters strong corporate governance and ensures 

that benefitting public company shareholders is the paramount consideration of all 

operative participants in the proxy voting process. 

The Chamber recognized that the best practices aspect of its efforts necessarily 

would require public discussion about this important component of corporate 

governance, and the Chamber Principles were designed to foster that public 

discussion and assist all participants in the proxy voting process in fonnulating 

sensible procedure to ensure that the interests of shareholders are paramount. Two 

proxy advisory [mus exert enormous influence vis-a-vis corporate governance 

standards, principles, concepts, voting and have effectively become de facto corporate 

governance standard setters. The Chamber's principles are intended to focus 

attention on this fact and the consequences that flow from it. In addition, a critical 

Chamber goal is to educate the public and foster discussions regarding the current 

lack of standards for, and oversight of, proxy advisory [mus, and the problems 

engendered as a result. 

More regulation is not the answer. Nor is there a need for the SEC fonnally to 

"institutionalize" the Chamber Principles-the core principles already exist, as a 

matter of state and federal law. Rather, the Chamber believes that Congress and the 

SEC should encourage public companies, investors, and proxy advisory firms to 

engage in the necessary dialogue to create a system that will impose transparency and 

accountability on proxy advisory Emus. This dialogue should build on other positive 

trends in the proxy system, including greater communication between companies and 

shareholders, and enhanced due diligence by asset managers in executing shareholder 

votes. 

18 
200 


81762.163

The Chamber has developed these best practices and core principles to 

improve corporate governance by ensuring that proxy advisory fInns: 

• Are free from conflicts of interest that could improperly influence proxy 

advisory firms' recommendations; 

• Ensure that reports are factually correct and establish a fair and 

reasonable process for correcting errors; 

• Produce vote recommendations and policy standards that are supported 

by data driven procedures and methodologies that tie recommendations 

to shareholder value; 

• Allow for a robust dialogue between proxy advisory fIrms and 

stakeholders when developing policy standards and vote 

recommendations; 

• Provide vote recommendations to reflect the individual condition, status 

and structure of each company and not employ one-size-fIts all voting 

advice; and 

• Provide for communication with public companies to prevent factual 

errors and better understand the facts surrounding the fInancial 

condition and governance of a company. 

Conclusion 

As I noted at the outset, I appreciate this opportunity to express my views on 

these important issues. We hope that Congress will support the Chamber's efforts to 

ensure transparency, accountability, and fairness in the activities of proxy advisory 

finns, and encourage all stakeholders to participate in this endeavor. We look forward 

to working with you on this important issue. 

I stand ready to try to assist the Subcommittee in any way I can, and to respond 

to any questions the Members of the Subcommittee might have. 

19 
201 


81762.164

TOM QUAADMAN 

VICE PnESIDhNT 

CENTER FOR CAPITAL MARKETS 

OMPETITIVENESS 

Mar 30,2012 

The t Ionorable l\faty Schapiro 

Chainnan 

U.S. Securities and Exchange Commission 

100 F Street, NE 

Washingron, DC 20549 

Dear Chainnan Schapiro: 

1615 H STREET, NW 

WASHINGTON, DC 20062~2000 

(202l 463- 5540 

tquaadman@u5charnber.com 

The U.S. Chamber of Commerce ("Chamber'') is the world's largest business 

federation representing the interests of more than three million businesses of every 

size, sector and reb>1on. The Chamber created the Center for Capit.-tl Markets 

Competitiveness ("CCMC'') to promote a modem and effective regulatory structure 

for capital markets to fully function in a 21 st century economy. The CCMC is highly 

concerned about the lack of transparency and tangible conflicts of interest in the 

operation of prox)' advisory finns, and it has previously requested that the Securities 

and Exchange Commission (USEC',) exercise supervision in this area. 

In this connection, the CCMC respectfully requests that the SEC closely 

monitor the activities of San Francisco-based proxy advisor (;I:ls", Lewis & Co., l".LC 

("Glass Lewis'') and its activist pension fund owner, Ont.~rio Teachers' Pension Plan 

Board ("Ontario''). Earlier thi~ month, Ont.~rio publicly announced its opposition to 

the Board of Directors of NYSE-listed Canadian Pacific Railway Ltd. ("C1",), which is 

currendy facing a proxy contest from an activist hed!,'" fund.' The very next day, 

Glass Lewis issued its vote recommendation which, like its parent Ontario, was in 

opposition to the C1' Board. 

Both Glass Lewis and Ontario claim dley make corporate governance decisions 

independendy of one another, but the fact that the owner's interests were made 

known to the public just prior to publication of the subsidiary'S vote recommendation 

demonstrates the very strong possibility that Ontario's own unique interests arc being 

! <'1'PD. \1'£: Gla$('; I...ewi$ Supports. \ckm:m's Cln.lIdi~tn P:l.cific Board Shltc" \'faU Street Joumal online (.\by 9.2012) • 

. \.valb.blc at; hllrt~.:...L.QnJl1\e:\n;;.wmj midc/BT rQ.~n l?t l'1W - !'2Gl)l.html 
202 


81762.165

Tbe Honorable Mary Schapiro 

May 30,2012 

Page 2 

deliberately reflected in Glass Lewis' vote recommendations, and tbat tbe mutual 

positions are being coordinated in some manner. The mere 

appearance of a tangible conflict of interest sbould be sufficient to justifY an inquiry 

by the SEC. 

The present situation witb CP is only the most recent and perhaps most severe 

instance of conflicts arising with respect to Glass Lewis and the activities of its activist 

owner. Last September, CCMC posed a similar issue to the SEC2, as Ontario had 

been publicly pressuring the McGraw-Hili Board to reorganize. In that letter, we 

urged tbe SEC to consider how the dynamic between the activist sbareholder parent, 

and tbe proxy advisor tbat it controls, could threaten to cause serious barm to tbe 

corporate governance system, adversely impact the integrity of proxy voting systems 

and observance of important fiduciary duties, and hamper the long-term management 

of a corporation. There should be a strong regulatory interest in understanding how 

Glass Lewis is managing these potential conflicts, if at all, today and in the future. 

The CCMC has filed several comment letters witb the SEC on tbe Concept 

Release on tbe U.S. Proxy System (File Number S7-14-10). In these comment letters 

tbe CCMC has expressed concern regarding tbe unaccountability and lack of 

transparency in tbe development of voting policies and vote recommendations by 

proxy advisory firms. Because of the importance of advisory firms in the proxy 

voting system, there should be clearly defined procedures and transparency in tbe 

development of voting policies and recommendations to provide certainty in the 

system, while avoiding potential conflicts of interest. These procedures should be tied 

to actual due diligence that demonstrates consistency between voting policies and 

tbeir implementation, on tbe one hand, and the economic interests of the actual 

individuals and fund participants purported to be served by the proxy advisor client. 

Failure of the advisory firms to avoid conflicts may harm corporate governance 

systems, undermine confidence in the market place, and endanger the ability of 

advisory firms' clients to meet their fiduciary duties as sharebolders. 

In commenting on the concept release the CCMC has called upon tbe SEC to 

create an oversight system to ensure tbe transparent development of voting policies 

1 CCMC le.rter 10 f:hainnan Schapiro IT: ~fcGraw~HilI (Sept~mbcr 12, 2011)~ Av:Ulable athttp://w\w/.cenlerfoocapltallmlrkets.com!wp.contcnt!uplo-Ads/201 O!04!.:\kGrnw» Hill·LetteI>9.122011. pdf 
203 


81762.166

The Honorable Mary Schapiro 

May 30,2012 

Page 3 

and reconunendations while preventing conflicts of interests in the operation of proxy 

advisory firms. The CCMC continues to stand by this position and accordingly 

requests that the SEC to investigate the potential conflict of interest in the CP matter 

and closely monitor the Glass Lewis ratings, regarding the actions of its parent 

organization, to prevent conflicts of interest and potential degradation of corporate 

governance through the misuse of proxy advisory services. 

We look forward to discussing this issue with you further. 

Sincerely, 

Iv 

Tom Quaadman 
204 


81762.167

TOM QUAADMA1\1 

ExECUTIVE DlRECIQR, FrNA.;."ilCIAL RE.PORTING 

AND INVESTOR OpPOR"IUNm· 

CENTER FOR CAPITAL MARKETS 

OMPETITIVENESS 

August 5, 2010 

The Honorable Mary Schapiro 

Chailman 

U.S. Securities and Exchange Commission 

100 F Street, NE 

Washington, DC 20549 

Re: Concept Release on the U.S. Proxy System 

File Number S7-14-10 

ruN 3235-AK43 

Dear Chainnan Schapiro: 

16151-1 STREET,NW 

WASHINGTON, DC 20062·2000 

(202) 463·5540 

tquaadman@uschamber 

The u.s. Chamber of Commerce is the W01:ld's largest business federation, 

representing more than three million businesses and organizations of every size, 

sector, and region. The Chamber created the Center for Capital Markets 

Competitiveness ("CMCC") to promote a modern and effective regulatory structure 

for capital markets to fully function in the 21st century economy. It is an important 

priority of the CMCC to advance an effective and transparent corporate governance 

structure. To achieve this objective, the CCMC has called for the elimination of 

regulatory dead-zones and gaps in regulatory coverage. 

With the increased weight of the institutional investor vote and the heavy 

reliance of institutional investors on proxy advisory finns, the CCMC believes that the 

lack of transparency, balance, and oversight of proxy advisory finns is a troubling 

regulatory gap that needs to be addressed. Accordingly, the CCMC believes that the 

U.s. Securities and Exchange Commission ("SEC") should put in place appropriate 

supervision to ensure the transparent development of voting policies and issuance of 

recommendations to prevent disruptions and lack of confidence in the systems 

governing the election of directors and consideration of shareholder proposals. A 

failure to address this lack of supervision over proxy advisory finns may lead to the 

undennining of the corporate elections and annual shareholder meetings leading to 

adverse consequences upon investors. 
205 


81762.168

The Honorable Mary Schapiro 

August 5, 2010 

Page 2 

Our concerns are listed in more specificity below. 

Background 

Because institutional investors own a majority of shares in the United States 

and have a fiduciary duty to vote them. the institutional investor vote has a significant 

impact on the outcome of corporate elections. In addition, retail investors do not 

have a similar legal obligation to vote their shares.l Because of the number of 

companies they are invested in, institutional investors will often delegate a proxy 

advisory firm to develop voting recommendations to fulfill their fiduciary duty to 

vote. Even before the SEC scaled back broker discretionary voting, studies suggested 

that proxy advisory firms' recommendations may sway up to 20% of the shareholder 

vote.' Recommendations of proxy advisory firms are potentially more influential 

follo",mg the SEC's action on broker discretionary voting. 

Simply put, in the scope of director elections and consideration of shareholder 

proposals, proxy advisory firms are a highly influential group that has no regulatory 

oversight. Indeed recent actions by the SEC and Congress will only increase this 

influence. Absent reforms to the manner in which proxy advisors set and implement 

voting pvlicies, such increased influence itself is prone to be out of alignment with the 

very interests it purports to further. Accordingly, the CCMC believes that it is 

necessary and appropriate for the SEC to require that proxy advisors adopt and 

follow operating procedures to provide assurance that the end product is derived 

from 3ppropriate diligence and objectivity. Till> will require the development and 

enforcement of transparency and dL,closure to create clearly identifiable rules of the 

road. 

The CCMC believes that proxy advisors may fail to reliably represent the 

investors they purport to serve for the following reasons: 

• Structural: Final voting recommendations and voting policies appear to be 

determined at the sole discretion of proxy advisors firm employees with no set 

guidelines or parameters. This creates a decision and policy development 

process that is arbitrary and capricious, potentially harmful to all investors. 

I Thr Chamber Joc~ have m::riolkl c()nccms rtg:uding ({)tail shareholder p:utlcipllriun and will me a $Cpar.Ltc comment letter with the 

.'i!~r.!t!1. pmpO-iahi to Increase remil ~harcho!dcr participation. 

2 The Impact of the Imtitutio"-tll and Regrtfatory Errmro7l.ment on Shareholder Vl'lling, Jcnrtifer E Hethel :and Stu;ut Gillan 

(2002) 
206 


81762.169

The Honorable Mary Schapiro 

August 5, 2010 

Page 3 

This creates opportunities for the vote to become skewed, biased, or 

misdirected. 

• Economic: Proxy advisors have an economic incentive to standardize and 

commoditize proxy voting, as a higher quality process that focuses on a voteby-vote and company-by-company basis demands greater corporate resources. 

As we all know, the "devil is in the details," and the risk here is that 

recommendations are made in a vacuum without diligent consideralion of the 

actual facts and context. In addition, no two companies are exactly alike and 

accordingly they should not be run in the same way. Unfortunately, economic 

incentives drive one-size-fits all policy which will not produce better informed 

investors or managed companies. 

• Vocal Minority: Because of a lack of accountability and transparency, it 

appears a small vocal group of activists are able to influence the development 

of voting policies and recommendations of proxy advisory firms. This leads to 

skewed voting patterns and results. By creating rransparent procedures, a more 

balanced system can be implemented that is more reflective of all investor 

interests. 

• Outdated Approach: The basic model for providing proxy advice was 

developed decades ago and has not kept pace with the changing times. Too 

often, the policy pronouncements fail to be backed up by extensive analysis or 

how one policy inter-relates ,vith another. The cookie-cutter approach fails to 

take into account differences on a company-by-company basis. The CCMC 

believes that the approach should be turned around: The primary focus should 

be on the company and its industry, and the advisor's "polides" or other such 

prescriptions should serve as analytical tools rather than ends unto themselves. 

The CCMC proposes that the SEC consider new rules that would directly 

govern proxy advisors and would have a simple focus: Ensuring that proxy advisors 

do what they say they are in business to do. Transparency and disclosed operational 

standards would provide regulators and the public on-going confidence that a proxy 

advisor actually provides the best possible voting recommendations to its clients. It 

may be too much to ask that proxy advisors analyze companies in the same holistic, 

case-by-case manner -- and with the same attention to detail-- as a financial analyst. 

However, we do believe that the SEC could take simple steps to ensure that proxy 

advisors have procedures in place that are at the very least reasonably designed to 

result in quality voting recommendations. Such rules would focus each on the 
207 


81762.170

The Honorable Mary Schapiro 

August 5, 2010 

Page 4 

process for determining voting policies and on the manner in which those policies are 

implemented. 

First, the SEC's rules sbould require proxy advisors establish and disclose 

written standards for making recommendations, including policies that are based on 

statistical and other evidence that is available -- or that may reasonably be deduced. 

The proxy advisor should be required not only to solicit input from all stakeholders, 

but also to give that input due and balanced consideration in a transparent manner. 

The implementation of these procedures, including related internal deliberations, 

should be transparent so that the public can assess their effectiveness and objectivity, 

and offer appropriate and timely input. 

Second, the SEC's rules should require that a proxy advisor has a process in 

place tbat demonstrates due care towards formulating accurate voting 

recommendations when applied in the unique context of each individual company. It 

could be similar to the government's use of the Administrative Procedure Act. As 

with the recommendation standards, this implementation process sbould be 

transparent. It should be apparent to the market, including the advisor's own clients, 

when a recommendation proves correct, and when it proves incorrect. Indeed, one 

consequence of such transparency might be to encourage proxy advisors to compete 

,vith each \}ther based on the qllali!J of their voting recommendations. 

We are not asking that the SEC prescribe the procedures adopted and disclosed 

by any given proxy advisor, and indeed we believe that each advisor should remain 

free to devise its own approach, to experiment with new technologies and concepts. 

However, those procedures should be transparent and readily understood to give all 

participants clear rules of the road and create a degree of certainty in the process. 

Rather, we are asking that tbe SEC focus on the final product, and require that each 

proxy advisor does what it is in business to do - help its clients carry out their 

fiduciary duties when it comes to proxy voting. This approach is analogous to the 

procedure that the SEC bas taken with credit rating agencies, by adopting rules 

designed to address concerns about the integrity and transparency of credit rating 

procedures and methodologies. 

There is ample basis for such regulation inasmuch as many proxy advisor 

activities amount to "solicitations" and as such dependent upon corresponding 

exemptions from the SEC. For example, Rule 14a-2(b) (3) could be revised to further 

condition the availability of the exemption provided by that rule. As the courts and 

the SEC have made clear, fiduciary duty includes not only a duty to disclose or 
208 


81762.171

The Honorable Mary Schapiro 

August 5, 2010 

Page 5 

manage conflicts of interest, but also a duty to ensure that votes are cast ",ith due 

care.3 

Accordingly, the CCMC respectfully requests that the SEC review the practices 

of proxy advisory firms and take the steps necessary, as outlined ahove, so they are 

held to standards of accountability and transparency that will make sure appropriate 

levels of oversight to insure investors are not improperly influenced or outcomes 

skewed. 

The CCMC ",-ill provide more detailed comments on the proxy plumbing 

release, but because of the increasingly influential role that proxy advisory firm's play 

in the governance of companies in the U.S., we believe that the issues regarding them 

should be addressed quickly and on a faster track than other issues contained in the 

concept release. We stand ready to work ",ith the SEC in this endeavor and look 

forw'ard to any efforts to insure transparency, accountability, and fairness in proxy 

advisory firms' role in corporate elections and consideration of shareholder proposals. ,'1tv 

~Quaadman 

CC: The Honorable Kathleen L. Casey, Commissioner, US. Securities and 

Exchange Commission 

The Honorable Elisse B. Walter, Commissioner, U.S. Securities and Exchange 

Commission 

The Honorable Luis A Aguilar, Commissioner, U.S. Securities and Exchange 

Commission 

The Honorable Troy A. Paredes, Commissioner, U.S. Securities and Exchange 

Commission 

3 ~>~. FiJl4l Rule: Proxy Voting by Investment Advisors, Invcstmmt ,\dvison; ,\ct Release No. 2106 (Ian 31, 2003) at 2 and 

note 2; SEC v. Capiral Gains ReseaTch BKrean. Inc., 375 U.s.. 180, 194 (1963) (lntcrpn::ting Scction 20G Qf the < \dv~ors Act). 
209 


81762.172
210 


81762.173

-=--~_ ::.--_-- _~_~ - - - ~ ~ - =-= ~- - __ - - -- _ - CO- ~-=- -=-_~ -=----_ ....: - ---_-

The U.S. Chamber's Center for CapitallVfarkcts Competitiveness has long advocated policies that 

promote effective shareholder participation in the corporate governance process. Strong corporate 

governance is a critical cornerstone for the healthy long-term performance of public companies and 

their positive promotion of long-term shareholder value. 

Proxy advisory fIrms, public companies, and investment portfolio manager organizations each play 

an important role in ensuring that corporate governance furthers the interests of shareholders 

through a process that relics heavily on fair shareholder communications and infonued 

participation. 

Over the past decade, important positive strides have been made to imprO\'e corporate governance, 

transparency, and accountability. Sarbanes-Oxlcy helped foster more active and independent public 

company boards; there has been a welcome and necessary 

increase in communications among boards, Inanagcnlcnt, and 

investors; and asset managers halT increasingly established 

programs to enhance their due diligence in executing 

shareholder \'otes, including robust internal capabilities 

focused on proxy voting as well as the use of proxy advisory 

fu:ms' recommendations as one of a number of data points to 

infonn their independent proxy voting decisions. 

flowever, there have also been some ncgative trends. In particular, annual proxy solicitations 

increasingly hal'e become a referendum on a growing and sometimes conflicting array of issues. ;\s 

the range of issues proposed in the name of corporate governance has grown, the need for clear, 

objccti\,C, and empirically based corporate governance standards has also grown to help 

management and investors cvaluate and improve corporate 

governance as a Dlcans of increasing shareholder \~alue. 

Proxy advisory fmus playa growing role in this process. They 

arc called upon to evaluate el'cry issuc for which corporate 

proxies are solicited and, in doing so, have become dejiltfo 

corporate governance standard setters for public companies. 

And yet, as thc invoh'emcnt of proxy advisory firms in 

corporate govemance-rclatcd shareholder voting issues has 

increased, their transparency in developing and 

recommending voting policies has not. 

P a g (' i 2 
211 


81762.174

Two firms, lnstitutional Sharcholder Services Ine. ("ISS") and 

Glass Le,,;s & Co., LLC ("Glass Lewis"), constitute 97% of the 

industry, and one of thcm employs a totlll of 180 

250,000 issues, spread oyer thousands of 

rom"·.,n,"', within a short six-month period. Because of 

(such as ISS oHering consulting se"'iees to 

comr,anJes abour which it renders proxy voting advice, 

ownership by acti"ist investors with defined 

onc-slzc-fits-al1 \~()ting adYlce, industry concentration, 

policymaking conducted largely outside the public eye, proxy 

advisory tirms' influence in corporate governance parallels (and 

pragmatically may exceed) that of formal standard setters, such 

as regulators, but without the corresponding benefit 

strong transparency and accountability. 

This has caused obstacles to good corporate gOYCrn(lflCC that, if unaddressed, lnay r('ycrsc the 

positive advances in corporate gon:rnance of the past 20 years. 

[0 order to advance this collaboration constructivciy, we haye set forth core principles and a series 

of specific improvements to serve as a basis for proxy firms, pnblic companies, and 

lovcstn1cnt portfolio lnanager organizations to engage 111 a to create a SYStc111 that brings 

transparency and accountability to proxy ad,;sory fimls and fosters strong corporate governance. 
212 


81762.175

Best Practices and Core Principles for 

Proxy Advisory Firms and Their Affiliates 

Proxy a(h-isoty finns and their affiliates ("lOA !<'inns") should provide clients with pwxy 

advice that furthers the interests and objectives of their clients_ To do so, PJ\ Finns must 

their research methodologies and conflicts of interest, and must regularly review and update their 

policies (based on their actual experience) to ensure that d1eir recoml1lendal10ns advance 

shareholder value_ To that end, best practices and core principles include: 

Potential Conflicts ofInterest 

• A P;\ Firm's acceptance and fulfillment of client retainers certifies that doe PA 1'irm--

a. Has the experience, competence, and resources to prcwide its services with appropriate 

diligence; 

b. Has carefully researched and taken into account all relevant aspects of a particular issue 

on which it is prm-iding addce, including infonuation, data, and views inconsistent with 

its ultin1atc recotnmcndation; 

c. Even after rendering initial advice, will provide clients ,,~th any information that the P A 

Finn receives from those companies about which doc P;\ Firm has rendered advice; and 

d. Is fully independent and conflict-free v\-1th respect to the client and each vote involved in 

each assignment. 

• ;\ P1\ Firm should develop and disclose an appropriate medoodology to ensure that it 

devotes appropriate resources to each assignrncnt. 

• ;\ P;\ Fiml should develop and disclose appropriate procedures regarding potential contlicts 

that may affect its recommendations; these procedures should include, among other things: 

a. Describing its current and recem interactions wido its adv-isory clients (and affiliates); 

b. Describing its recent interactiollB \\-1th anvone having a marel,ial interest (posit-ive or 

negatiw) in tl,e subject of the ad,-ice; 
213 


81762.176

c. Identifying aU its recent interactions \V~th anyone relating to the suhjects of its proxy 

advisory services; 

d. Disclosing if the proponent of any shareholder proposal on which it \V~ll proyide advice 

is a client, or has any other relationship mth the PA Firm pnwiding benefits to the 

proponent; 

e. Understanding, and determining whether it can facilitate, the objectives of its adyisory 

chents; 

f. Providing full disclosure to prospccti,'c clients of all potential conflicts and 

interrelationships, without requiring any action or analysis by its prospective clients; and 

g. J\ff=ativcly representing to prospective or existing clients, in connection \V~th each 

project:, the nature of any conflict that could affect its ability to render fair and impartial 

advice. 

• J\ P J\ Firm's acceptance of an assignment certifies, among other things, that tl,e P A Firm's 

advicea. Relates to a subject on which the FA Firm is (or \v~ll be) competent to opine; 

b. Reflects (and sets forth) adyicc that carefully considered significant alternative and 

countervailing argun1cnts; and 

c. Discloses the extent to which the same advice On the same subject has been (or mll be) 

rendered to other clients, and the reasons why this advice is consistent \v~th differing or 

multiple chent interests and objectives. 

• A PA Firm should have policies and procedures in place to ensure that the advice it provides 

is consistent \V~th and in furtherance of its clients' interests and objectives. 

• \Y/hen communicating their reconnnendations to investment portfolio manager 

organizations ("IPMOs"), PA, Finns should affirmatively advise that the recommendations 
214 


81762.177

(and their underlying research) are intended solely as guidance to assist 1PMs in exercising 

their own jndgment on each significant voting issn(, and that the ultimate ,'oting decision 

cannot be delegated to or exercised by the 1\\ Firm, 

• PA Finm should provide IPl\[Os with a t110rough understanding of the P,\ Firm's collection 

and nsc of data, as well as tbe methodologies that the p",\ I'irm employs in developing 

advisory rcseu·ch. 

• PA Firms should obtain from each IPMO, with respect to each engagement, a full and fair 

understanding of the in\'es(ors' interests in managed [umb. 

• P;\ Firms should provide IPMOs with robust substantive res catch on rdevant issues, as weD 

as the advantages and disadvantages of any \'oting advice. 

• In rendering advice to TPMOs, 10;\ Firms should state in writing: 

a. The percentage of the community of funds similarly situated to those that the IPMO· 

client manages that receivcd (or will receive) the same achice rendered to tbe TPMO· 

clicnt; 

b. ;\ reasonable time after voting ends, the percentage of similarly situated funds that 

received the same advice from the P:\ Firm and that the PA Firm reasonably believes 

have implemented the same advice; and 

c. The way in 'i.vhich the P A 'Finl) dctct"1llincd that its advice. furthers the interests and 

objectives of its clients. 

Research 

• PA Firms should adopt and disclose clear policies and procedures to ensure the accuracy of 

data contained in tl1eir reports and on which their recommendations arc based. 

P ,\ Firms should adopt policies and procedures to govern their CotID11Unicat1ons and 

dcalings with public companies ("PCs") and other interested persons and cntities on a timely 

basis. 
215 


81762.178

~-=- --=-~----=- - - ----- - - -- - - - -- - ----- - -~-----=~ 

• PA Firms should provide PCs with drafts of proposed research reports relating to those PCs 

about which the PA Firms' research reports relate, sufficiently in advance of finalizing those 

reports, to enable the subject PCs to identify any factual inaccuracies or other concerns. PCs 

should be afforded a reasonable opportunity to seck advice about tl,e draft research reports 

from external advisors, subject to appropl~ate confidentiality restrictions. 

• PA Firms should explain their methodologies to clients in sufficient wl~tten detail. 

• PA Firms should, consistent witll protecting their proprietary data, provide interested 

persons-including PCs, TPMOs, investors, regulators, and the public-,,,~th analytical 

methodologies and modeling utilized in their research. 

• P;\ Firms should review the effects of their recommendations six months, or as practicable, 

after relevant proxy votes, and publish those results (,~th other necessary data) to permit 

interested persons to assess the accuracy, validity, and appropriateness of the pj\ Firm's 

recommendations. Rcports of tl,cse reviews should be published biannually, distinguishing 

between results for proposals and contests. These reviews should permit regularly revisiting 

and, if appropriate, modifying, proxy w)tmg poli6es to cnsurc that: they have a positivc--{lr 

at a minimum no negative---effect on shareholder value. 
216 


81762.179

Best Practices and Core Principles for 

Public Companies 

pes should engage in a dialogue \vith shareholders to understand d,eir interests. /I.S part of their 

broader shareholder communications strategy, PC:s should endean)r to communicate with proxy 

advisory firms on corporate governance matters so that shareholders may e\'aluate what is at stake 

for d,em \V~th respect to any matter presented for shareholder approvaL \'Vith the passage of 

Sarbanes-Oxlcy and \'arious corporate initiatives, shareholder communications, board 

independence, and accountability ha,·c increased. To ensute the continuation of these positive 

trends, the following best practices and core principles should be followed: 

PCs ty1)ically interact· with p"\ Finns in one of two ways: 

a. PC:s hold shareholder votes on a variety of matters, and encounter 1'"\ Firms when PC:s 

solicit proxies ("Proxy Engagcment"); and/ or 

b. pes occasionally purchase services from P J\ Finns relaring to corporate governance 

issues ("Purchasing Services"). PC Boards must discharge their fiduciary duties when 

interacting \v~th P [\ Finns in Proxy Engagement or Purchasing Services, and must act in 

their shareholders' best interests. 

PC Interactions with PA Firms 

• Before Purchasing Services from or undertaking Proxy Engagement with a P 1\ Firm, PCs 

should undertake to adequately understand, among other tbings: 

a. 1\n)' prevailing PA Finn and PC institutional shareholder assessments of the PC's 

corporate governance; 

11. General knowledge of their shareholder base and the relative likelihood that the 

company's shareholders would bc influenced by PA Firms (or particular PA Films) in 

nlaking those voting decisions; 
217 


81762.180

c. Methodologies that the P A Firm employs with respect to the types of matters on which 

tJ,C PC's shareholdcrs \vill votc or with respect to which the PC intends to obtain a PA 

Firm's advice; and 

d. Contlict-avoidancc policies and procedures utilizcd by thc PA Finn, espccially witJ, 

rcspect to matters of the type for which the PA Firm's services will be songht. 

PC Engagement with P A Firms 

• PCs should determine if the decision-making process to engage a P I\ Firm is a matter of 

routine busincss, or if it may be necessary to involve independent board members in 

decisions on whetJ,er to engage a P A Firm on specific proxy issues. 

• As part of their proxy disclosure obligations, and to avoid confusion or misperceptions on 

the part ofPA Firms, PCs should make meaningful disclosure to their shareholders of the 

underlying reasons for any proposal, election contcst, or transaction for which shareholder 

votes will be sought. 

• PCs should ensure timely public disclosure of all significant infOlmation that the PC intends 

to provide, or has provided, to any P A Firm. 

• Before engaging in cliscussions with P A Firms about matters to be submitted to a 

shareholder vote, PCs should, among other things: 

a. Identify the main issues that PA Firms likely will focus upon in the next annual proxy 

solicitation period; 

b. Research various positions favoring or opposing the issues idcntified; and 

c. Develop an effective rationale for tJ,C PC's position on those issues. 

• PCs should attempt to have appropriatc pcrsonnel review and analyze the market's reaction 

to specific P A Firm recommendations and, if relevant, consider sharing that analysis with the 

invcs ring public. 
218 


81762.181

• PCs should publicly disclose changes they make to existing governance policies and practices 

as a result of their interactions \Vith FA Firms. 

PC Interactions with PA Firms as Service Providers 

• In deciding whether to purchase a pj\ Firm's services vis-a-vis governance matters, PCs 

should ascertain and evaluate whether the p"-\ IJirma. Would also provide advice and recommendations to IPMOs on voting their holdings of 

the PC's shares; 

b. Discloses to IPMOs (in advance of or concurrently with distributing its voting 

recommendations) whether the PJ\ Firm has an existing relationship with PCs about 

which the PA Firm [enders advice; 

c. Will allow the PC to re"iew draft recommendations that the PJ\ Finn may be planning to 

make regarding voting issues, to enable the PC to correct factual errors or address 

misperceptions; and 

d. Renders advice tailored to the specific circumstances affecting the Pc. 

P :;" 1 10 
219 


81762.182

Best Practices and Core Principles for 

Investment Portfolio Manager Organizations 

There is a broad variety of 1PMOs-that is, persons or entities exercising or influencing investment 

and proxy voting decisions on behalf oj~ among others: individual investors; hedge funds; mutual 

funds; corporate, state, municipal, and labor union pension funds; endowment funds; trust funds; 

bank collective investment funds; investment banking finns; venture capital hillds; insllrance 

companies; and commercial banks. Because IPMOs manage or influence the disposition of the 

assets of others, they are obligated to ensure that their proxy voting decisions renect their 

independent jndgment, and arc intended to further the best interests of their shareholders, 

investors, and clients. 

Recendy, some 1P]\[Os bave utilized P A hrms as one of sC\'Cral somces in formulating 

independent voting decisions on highly significant issues, consistent ,,~th the interests and 

objectives of their shareholders, investors, and clients. This positive trend, in conjunction \vith the 

increased dialogne hetween public companies aml shareholders, has improved the proxy voting 

process. Where IPMOs arc already structured to facilitate the exercise of their independent 

judgment, the best practices discussed below arc merely suggestions of alternative ways operative 

core principles might be achieved. '-""here IPMOs are not already structured in a mauner that 

ensures their exercise of independent judgment in satisfying proxy voting responsibilities, the 

following best practices and core principles arc intended to guide IPMOs' receipt of necessary data 

from PA Firms. 

• IPMOs must exercise independent judgment when developing and executing voting 

guidelines and standards with respect to highly significant and nonrout1ne proxy-related 

matters on which they receive a PA Firm's recommendations. 

• [PMOs' responsibilities extend beyond the investment decisions they make, to all facets of 

their efforts on behalf of d,cir shareholders, investors, and clients, including the exercise of 

voting power in connection \v~th portfolio assets. 

• While [PMOs can use outside experts to assist them with d,eir respousihilities, the llltimate 

responsibility to act in the best interests of their shareholders, im-cstors, and clients always 

remains widl the IPMO. 

P.,)," 111 
220 


81762.183

Selection and Use of PA Firms 

• IPJvIOs should identify the el1teria they will employ, and the practices they will follow, in 

retaining or continuing to retain a P;\ Finn. 

• The policies and practices pursuant to which TP1\10s select PA Firms should be developed 

or approved hy an independent authority within (or aftiliated wi(1) the IPMO. Periodically 

thereafter, the same independent authority should re\·jew d,c manner in which the IPJ\[O's 

and procedures arc implemented, to provide reasonable assurances mat the selection 

Pi\ Firm is consistent with the best interests of the IP;\[O's shareholders, investors, and 

clients. 

• While many items presented for a shareholder H)tc are uncontested or nncontroversial, 

some items are contested, by their nature lend mC111sclves to strong differing views, or can 

have a significant impact on shareholders. For items in the latter categories me 11'MO 

should consider dle follo\"~ng criteria, among others, when reraining or continuing to retain 

a PJ\ Firm: 

a. \Vhedler t.he PA Firm maintains transparent policies and procedures to allow an IPMO 

to make a reasonable determination that adyice received is consistent witl1, and furthers, 

the interests and objectives of their shareholders, investors, and clients; 

h. Whether the P "'\ Firm has adccluate experience to render the type of advice for which it is 

being retained; 

c. Wherher the lOA Firm discloses actnal or potential conflicts of interest related to the 

rendering of advice or recomlncndations such d,at dIe TPMO ,vould be aware of their 

existence, and whether utilizing the P;\ Firm's ad\'ice presents actual or potential 

conflicts of interest \1.'ithin the [1'MO; 

d. \Vhcthcr the PA Firm has carefully considered and communicated to the IPMO 

significant and countervailing \'iewpoints known by the PA Firm; 

e. Whemer the Pi\ Firm discloses the extent-·--if any-to \vhieh the same achice on the 

same subject has been rendered to its other clients, as well as the reasons mat this advice 

is nonetheless consistent \vith, and furthers, the best interests of the IPMO's clients; 
221 


81762.184

f. Whether the P A Fim1 provides reports on internal controls to give TP 1\10s reasonable 

assurance of the accuracy of the data in their reports and recommendations; 

g. Whether the PA Finn provides an adequate explanation of, and the data underlying, its 

methodologies and modeling; and 

h. Whether utilizing the PA Firm's advice presents actual or potential conflicts of interest. 

• Before selecting a P;\ Firm, or continuing to use a PA Firm, the IPMO should be satisfied 

that it understands the PA !'inn's methodologies, and that both these methodologies, as well 

as the PA Finn's recommendations, further the interests and objectives of the IPMO's 

shareholders, investoro, and clients. 

• IPlv!Os should vest ultimatc decision-making authority on whether and how to excrcise 

proxy-related decisions solely in a person (or persons) possessing the ultimate auth01~ty to 

exercise judgment on how to vote the IPMO's shares. This does not preclude IPl\!Os from 

delegating vote execution or clel~cal tasks to one or more third parties (which may include a 

lOA Firm). 

• IPMOs should regularly assess and be comfortable \\~th thc performance and reliability of 

any PA Finn. 

Tn rare circumstances that lPMOs may confront potential conflicts that can affect a 

particular votc, those issues maybe best resolved by applying solutions appropl~ate to each 

JPMO and not standardized guidance. 
222 


81762.185

Written Testimony of 

Darla C. Stuckey 

SVP, Policy & Advocacy 

Society of Corporate Secretaries and Governance Professionals 

June 5, 2013 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

United States House of Representatives 

"Examining the Market Power and Impact of Proxy AdviSOry Firms" 
223 


81762.186

Introduction 

My name is Darla C. Stuckey and I am Senior Vice President, Policy & Advocacy, of the 

Society of Corporate Secretaries and Governance Professionals (the "Society"). The Society is a 

professional association, founded in 1946, with over 3,000 members who serve more than 

1,500 public, private and non-profit organizations. Our members seek to develop corporate 

governance policies and practices that support our boards to foster the interests of long term 

stockholders. Our members generally are responsible for their companies' compliance with 

the securities laws and regulations, corporate law, and stock exchange listing requirements. 

More than half of our members are from small and mid-cap companies. 

Background 

The Subcommittee has asked for our testimony on the services provided by proxy 

advisory firms to shareholders and issuers to determine whether these entities are providing 

unbiased opinions and if conflicts of interest exist. The Subcommittee has also asked for our 

views on the market power of proxy advisory firms, and their ability to promote agendas 

supported by narrow or single-issue shareholders. 

Beginning in the 1980s, regulators have pushed institutions to use their voting power, 

with limited regard for costs of voting from an informed fiduciary standpoint. Major regulatory 

landmarks in this regulatory push include a Department of Labor (DOL) letter (the "Avon 

Letter") in 1988, and 2003 SEC rules to require that every mutual fund and its investment 

adviser disclose "the policies and procedures that [they use] to determine how to vote 

proxies". The purpose of the SEC rules was to "encourage funds to vote their proxies in the 

best interests of shareholders" and to avoid conflicts of interest between those shareholders 

and the fund's "investment adviser, principal underwriter, or certain of their affiliates." 

Unfortunately, the rule became a classic case of unintended consequences. Many 

institutional investors largely outsourced their shareholder voting policies to a proxy 

advisory industry that relies on ... "one-size-fits-all" policies .... Instead of eliminating 

conflicts of interest, the rule simply shifted their source. Instead of encouraging funds to 

assume more responsibility for their proxy votes, the rule pushes them to assume less. 

Instead of providing informed, sensitive voting on proxies, the incentive has been to 

outsource decision making to two small organizations that most investors have never 

heard of. These two firms have emerged as the most powerful force in corporate 

governance in America today, shaping the way that mutual funds and other institutions 

cast votes on proxy questions posed by about 5,000 US public companies.' 

1 James K. Glassman and J. W. Verret, How To Fix Our Broken Proxy Advisory System, George Mason University, 

2013 at page 6. 

- 2-
224 


81762.187

I. A SIGNIFICANT PERCENTAGE OF INVESTORS ARE INDIFFERENT TO VOTING AND THUS 

OUTSOURCE THEIR VOTE 

Shareholdings in public companies are increasingly held by individuals through mutual 

funds and other intermediaries who have the right, and obligation, to vote the shares held. 

For this reason there is an increasing lack of connection between beneficial ownership and 

voting decisions. "Institutional investors vot[e) ... portfolio company shares [by) delegate[ing] 

all but the most obvious economically related voting decisions to either an internal or external 

corporate governance team that is largely, or all too often totally, separate from the 

investment policy decision making team- in effect, a parallel universe of voting decision 

makers.'" "Over the past decade, the SEC and Congress have increased regulation focused on 

institutional investors voting. An explicit assumption in this regulation was that institutional 

investors would conduct the research necessary to vote in a manner that would maximize 

value for all firm shareholders. Unfortunately institutional investors face a classic free rider 

problem in conducting this research and may not have economic incentives to make such an 

investment.',3 

Reading and analyzing proxy statements is time consuming, requiring many hours of 

effort and analysis. A portfolio manager or his or her in-house governance analysts would 

need to expend significant resources to review individually the proxy materials of each 

company his or her fund owns. There are few investment managers who will allocate capital to 

voting decisions that they believe will not generate any return on investment. In short, proxy 

voting, other than in a contested election or similar "bet the farm" type scenario, is simply not 

worth the cost. A recent study titled Outsourcing Shareholder Voting to Proxy Advisory Firms, 

David F. Larcker and Allan L. McCall, Graduate School of Business, Stanford University, and 

Gaizka Ormazabal, lESE Business School, University of Navarra (Draft May 10, 2013), makes this 

point: 

The important public policy issue in this setting is whether the payments made by 

institutional investors are sufficient for the proxy advisory firms to engage in costly 

research to develop "correct" governance recommendations from the perspective of 

firm shareholders. If the institutional investors are only using the proxy advisor voting 

recommendations to meet their compliance requirement with the lowest cost, these 

payments will not compensate proxy advisors for conducting research that is necessary 

to determine appropriate corporate governance structures for individual firms.4 

Added to this is the collective action problem inherent in the current structure of the 

proxy voting system. Generally, institutional investors have little incentive to give sufficient 

2 Latham & Watkins, Future of/nstitutional Share Voting Revisited; A Fourth Paradigm. September 2011. See also, 

Nathan, Charles M. and Mehta, Parul, The Parallel Universes of!nstitutionallnvesting and Institutional Voting. April 

2,2013 

3 Larcker, David F., McCall, Allan l. and Ormazabal, Gaizka, Outsourcing Shareholder Voting to ProxvAdvisorv Firms, 

May 10, 2013at 43. 

, Larcker, McCall and Ormalabal at 3. 

- 3 -
225 


81762.188

time and resources to intelligent voting, since the investor knows that with a small ownership 

interest in the company, the fund's vote will have limited direct impact at a company. (A fund 

investor that holds 1% of the vote seldom will change the outcome of a vote; those owning less 

of a company's shares have even smaller direct impact.) This dynamic creates downward 

pressure on the quality and thoroughness of analysis related to proxy votes, particularly those 

that have in the past been regarded as "routine" (e.g., election of directors in non-contested 

situations). As proxy voting in non-contested meetings has become more important, 

particularly with the advent of say-on-pay, this disconnect can result in damage to the longterm interests of the company. 

Thus, outsourcing these reviews to proxy advisory firms is pragmatic and rational for 

institutional investors, many of which say they cannot analyze the hundreds of proxy 

statements for their portfolio companies, particularly given the ever-increasing length and 

complexity of such materials.s Some investment managers openly tell issuers that they follow 

proxy advisory firm recommendations without questioning them, and without shame or 

embarrassment. As one Society member notes: "Many hedge funds that are in our top 25 

shareholders by holdings refuse to engage with us when we call because they say that they 

follow ISS recommendations." And, another Society member stated that "many mutual funds 

buy research from proxy advisory firms; certain firms are required to justify any vote that is 

NOT in accordance with the proxy advisory firm' recommendations". Investment firms openly 

use proxy advisory firm reports as substitutes for the actual proxy statements (think Cliff's 

Notes). Proxy statements are subject to '34 Act and 10b5-1Iiability. Proxy advisory firm 

reports are not, yet they are being relied upon just as heavily, if not more so, by investors to 

make voting/investment decisions. Furthermore, many investment managers do not even read 

the proxy advisory firm reports; in fact there is a "recommendation only" service from one 

provider that investors can purchase at a lower price that will nevertheless satisfy their 

compliance obligation.6 

Outside of a proxy fight context, proxy advisory firms tend to implement mechanical 

policies, including check-the-box approaches that clients can tweak in "custom policies" that 

still are severely constrained analytically. The proxy advisory firms have an interest in 

perpetuating the view that such check-the-box approach to proxy voting-a demand they can 

fill at low cost-is adequate. We believe simple-minded voting algorithms may be an 

appropriate way to approach certain issues. But this method does not work well in what have 

become the dominant and most consequential proxy voting decisions in routine elections in 

the wake of various reforms enhancing shareholder power - election of directors, and 

executive compensation (through the advisory vote on pay). 

'The Society understands that some of the very largest investment managers develop their own voting guidelines 

and use proxy firms to "supplement" their own evaluation of agenda items. This fact notwithstanding, the 

influence of the proxy advisory firms is substantial. 

6 See larcker, McCall and Ormazabal at 3. 

- 4-
226 


81762.189

II. PROXY ADVISORY FIRMS ARE NOT REGULATED AND HAVE NO OVERSIGHT 

ACCOUNTABILITY FOR THEIR RECOMMENDATIONS 

As noted by the Commission in its concept release, proxy advisory firms are one of the 

few participants in the proxy voting process that are not generally required to be registered or 

regulated by the SEC. There is no accountability by proxy advisory firms even though, given the 

current structure of the proxy system, they control anywhere from 20-40% of the vote 

collectively on so-called "routine" matters at widely held companies. 7 When proxy advisory 

firm recommendations come out, large blocks of votes are cast almost immediately in 

automated voting decisions. These ripple out both from clients that follow the main policy of 

each advisory firm, and those that have so-called "custom policies" that are tweaked based on 

simplistic mechanical inputs. Proxy advisory firms are not beneficial owners of any company's 

shares. 

Thus, the two largest proxy advisory firms each effectively control a portion of the vote 

that is much larger than the Schedule 13D threshold (5%), and even larger than the 10% 

affiliate status threshold, yet they are not subjected to any kind regulatory regime. Proxy 

advisory firms may produce reports with material misstatements and omissions without any 

legal consequences for the proxy advisory firm. One of the two dominant advisory firms, ISS, 

has registered as investment advisors, but no other firm has. Proxy advisory firm 

recommendations are tantamount to soliciting material in that they tell investors how to vote, 

but they are selectively disclosed only to paying customers and only sometimes to issuers. B 

Proxy advisory firms voting policies are also unregulated. There is no regulatory regime 

that governs the manner in which these firms develop their policies or form the 

recommendations they make. The policy development process at proxy advisory firms is not 

sufficiently transparent.9 It is not clear who actually participates in the process of policy 

development. Although ISS provides companies with an opportunity to weigh in on their policy 

survey, the questions often are skewed,lO which create biased policies that seem to reflect 

7 We believe there is a trend towards greater voting independence of large mutual fund complexes, but a large 

number of smaller investment managers (and some oftbe larger managers) continue to follow the proxy advisory 

firms closely, and sometimes without even reading the research. 

8 We note that there are differences between Institutional Shareholder Services ("ISS") and other proxy advisory 

firms such as Glass Lewis. We have tried to be specific in this letter, but the majority of the examples raised herein 

relate to ISS, primarily because of its dominant market share and our members' interaction with ISS. Importantly, 

we note that Glass Lewis only recently has begun to engage consistently with issuers and, for this reason, the 

interaction of the Society members with Glass Lewis as it relates to vote recommendations has been limited. 

9 See Stanford Closer Look Series (February 25, 2013) for a critique of the policy development process at ISS and 

Glass Lewis. 

10 The questions too often biased and the choice of responses are not appropriate for companies that complete the 

survey. Society comment letters and other member comment letters explain the biases, the lack of transparency 

and the design flaws in ISS's survey process. For example, ISS asked this question in its 2011 Policy Survey with 

options for a "yes" or fino" response: uln 2011,a handful of issuers required that, in order to call a special meeting, 

a shareholder or group of shareholders must hold the requisite ownership threshold in a net-long position. This 

requirement prevents shareholders seeking to call a special meeting from, for example, borrowing shares from 

another shareholder to satisfy the ownership criterion. Does your organization find this restriction to be 

sufficiently onerous to raise board responsiveness concerns?" See also, Larcker1 McCall, and Brian lavan, (lAnd 

- 5 -
227 


81762.190

narrow agendas of certain types of investors. Moreover, while ISS pOints to its survey as proof 

that their policies are representative, it appears that only a small number of investors respond 

to the surveys, and ISS has not recently provided information on the percentage of institutional 

clients responding. 

The rise of proxy advisory firms as intermediaries in the voting process has come 

directly from government regulation, with ISS establishing its market position in the years 

following the Avon letter, and Glass Lewis formed at the time of the SEC reforms. Both firms 

have gained significant traction since then. As noted above, regulation from the SEC,l1 wellintentioned at the time, coupled with DOL pronouncements that have contributed to the belief 

for many funds that they are required to vote (which they aren't) from a fiduciary perspective. 

Because of the position that the DOL and the SEC have taken, they have created an 

opportunity (the need) for proxy advisory firms. The SEC, the DOL, and other agencies should 

revisit these interpretive positions. 

The Society believes that proxy advisory firms should be registered with the SEC. 

Moreover, if government regulation continues to put an onus on institutions to vote in nearly 

all cases, regardless oftheir direct economic interest, then the government also should provide 

some oversight to ensure that institutions are not simply taking a lowest-cost, lowest-commondenominator approach that essentially shirks rather than embraces their fiduciary obligations. 

Voting has become more consequential in the life of companies, and with this comes a need 

for increased investor responsibility. 

The SEC should reconsider whether proxy advisory firms should be exempt from the 

proxy solicitation rules (Exchange Act Rule 14a-2(b)(3)). This would help ensure that fiduciary 

obligations of good faith and due care are properly carried out by all participants in the 

process. Greater oversight of the entire proxy voting system would facilitate transparency, 

reduce conflicts of interest, and provide greater discipline in the way vote recommendations 

are determined, thereby ensuring that votes are cast in the financial best interests of the 

beneficial owners. 

Our concerns about the current proxy advisory firm business, along with our 

suggestions for potential improvements to the current model, are described below. Our 

comments are organized as follows. First, we describe the influence of proxy advisory firms. 

Second, we discuss the harm to the integrity of the vote as a result of proxy advisory firms' 

factual inaccuracies, as well as the application of "one size fits all" policies applied without 

Then A Miracle Happens!: How Do Proxy Advisory Firms Develop Their Voting Recommendations?", Stanford Closer 

Look Series, February 25, 2013. 

1l See, Proxy Voting by Investment Advisers, Investment Advisers Act Release No. IA-2106 (Jan. 31, 2003). 

However, the SEC did note that failure to vote would not mean breach of fiduciary duties. It stated, "We do not 

suggest that an adviser that fails to vote every proxy would necessarily violate its fiduciary obligations. There may 

even be times when refraining from voting a proxy is in the client's best interest, such as when the adviser 

determines that the cost of voting the proxy exceeds the expected benefit to the client. An adviser may not, 

however ignore or be negligent in fulfilling the obligation it has assumed to vote client proxies." 

- 6-
228 


81762.191

judgment about what is in the economic best interests of the shareholders of a particular 

company on a particular issue. Third, we set forth suggested improvements in the procedures 

of proxy advisory firms to: 0) increase transparency in the formulation of voting policies, (ii) 

mitigate the potential for factual mistakes, and (iii) give issuers more time to review voting 

recommendations and allow issuer comments on reports. Finally we set out proposed 

regulation that would require SEC oversight of proxy advisory firms and require registered 

investment advisors to oversee the work of such firms to ensure accuracy and transparency. 

III. PROXY ADVISORY FIRMS HAVE SIGNIFICANT INFLUENCE ON VOTING OUTCOMES AND 

CORPORATE BEHAVIOR 

The influence of proxy advisory firms is no longer questioned. Proxy advisory firms 

exert a significant influence on matters presented for shareholder votes. Our Survey of Society 

members in 2010 indicated that 50% of respondents believe that at least 20% of their shares 

are voted in line with proxy advisory firm recommendations. Asked differently, 82% of our 

respondents indicated that proxy advisory firms have a "material impact" (defined as 

influencing 10% or more) on the vote. 

As noted above, our members witness votes cast in line with proxy advisory firm 

recommendations immediately when the report and vote recommendations are distributed. 

For example, one of our Society members stated that one year when ISS was very late in 

releasing its report, the member's company's vote levels were similarly delayed but running 

96% in favor of directors. When ISS did release the report, the company's quorum increased 

from 24% to 37% (13%) within a day (the short time frame suggesting little independent 

deliberation by the funds using ISS) and the vote in favor of directors dropped to 80% following 

the ISS recommendation. 

Similarly, as noted in a comment letter from IBM12, in 2009 and 2010, an estimated 

13.5% and 11.9% of the total votes cast in each year for IBM's annual meeting were cast lockstep with ISS's recommendations within one business day after the release of ISS's report. For 

the previous five business days, no more than 0.20% and 0.27% of the total IBM votes were 

cast in anyone day. "To put that into proper perspective, the IBM voting block essentially 

controlled by ISS has more influence on the voting results than IBM's largest shareholder. 

And this voting block is controlled by a proxy advisory firm that has no economic stake in the 

company and has not made meaningful public disclosures about its voting power, conflicts of 

interest or controls." To be clear, many companies believe that the ISS influence is far greater 

than the significant "one business day" impact noted above; however, that additional influence 

is difficult to quantify because institutional investors are not required to publicly disclose when 

they in essence "outsource" decision making over proxy matters to ISS or other third parties. 

"International Business Machines, Comment Letter, Concept Release on the U.S. Proxy Season. October 15, 2010 

-7-
229 


81762.192

One Society member faced the same shareholder proposal in 2012 and 2013, 

advocating an independent chair. In 2012, ISS supported the proposal, which received 39% 

support. In 2013, ISS changed its position to oppose the proposal, which then received 19% 

support. There had been no change in the company's practices that would merit such a 

change; rather, a mechanistic and simple-minded trigger for the ISS policy caused a 20% swing 

in the vote. 

Another Society member stated this year that Glass Lewis controlled 8% of the vote 

which was evident from a recommendation made a against a proposal and the vote count 

coming in immediately following the issuance of the report. 

The influence of proxy advisory firms is reflected not only in voting totals. The threat of 

an "against" or "withhold" vote by a proxy advisory firm often causes companies to adopt 

practices in order to ensure that they will get the favorable vote. Half of the Survey 

respondents noted that their companies have withdrawn or modified a proposal based on the 

expected voting recommendation of a proxy advisory firm and of those, 63% stated that the 

primary reason for the change or withdrawal was because they believed the adverse 

recommendation could materially impact the vote results. 

Corporate boards and committees spend an inordinate amount of time ensuring their 

policies and practices fall neatly within proxy advisory guidelines in order to avoid unfavorable 

vote recommendations these firms. This is particularly the case with respect to decisions on 

executive compensation design, a key driver in the achievement of corporate success and longterm shareholder return. 13 Society members say that in considering executive compensation, 

directors increasingly ask, "What will ISS say?" And evidence suggests that this influence does 

not enhance shareholder value. A recently published study found, "proxy advisory firms ... 

induce the boards of directors to make compensation decisions that decrease shareholder 

value." The authors write: 

We examine the shareholder value implications of outsourcing to proxy advisory firms 

on the recent requirement to implement Say-on-Pay .... [W)e confirm that proxy 

advisory firm recommendations have a substantive impact on SOP voting outcomes. We 

also find that ... a significant number of boards of directors change their compensation 

programs in the time period before the formal shareholder vote in a manner that better 

aligns compensation programs with the recommendation policies of proxy advisory 

firms .... We interpret our result as evidence that boards of directors change executive 

compensation plans in order to avoid a negative SOP recommendation by proxy 

advisory firms, and thereby increase the likelihood that the firm will not fail the vote (or 

JJ In a recent survey conducted by The Conference Board, NASDAQ and the Stanford Rock Center for Corporate 

Governance, over 70% of the director and executive officer respondents indicated that their compensation 

programs were influenced by the policies of and/or guidance received from proxy advisory firms during their 

evaluation of say-on-pay. The increase in the use of relative TSR over a 3-year time horizon as a performance 

metric is directly attributable to the methodology used by ISS to evaluate performance plan design. 

- 8-
230 


81762.193

will garner a sufficient level of positive votes). The stock market reaction to these 

compensation program changes is statistically negative . ... [W]e believe the most ... 

plausible conclusion is that the confluence of free rider problems in the voting decision, 

regulation of voting in institutional investors, and the decision by the SEC to regard 

proxy advisor policies as appropriate for purposes of institutional investor compliance 

with regulation has led to policies of proxy advisory firms that induce the boards of 

directors to make compensation decisions that decrease shareholder value. 14 

As a result of the role proxy advisory firms play in formulating and establishing 

governance standards and the extent to which institutional fund managers follow those 

standards, proxy advisory firms have become the "de facto" arbiters of corporate governance 

practices. The New York Stock Exchange ("NYSE") Commission on Corporate Governance 

issued a report on September 23, 2010, that explicitly recognized the influence that proxy 

advisory firms have on the market. The NYSE Commission on Corporate Governance also 

recommends that the SEC should "require [proxy advisory] firms to disclose the policies and 

methodologies that the firms use to formulate specific voting recommendations, as well as 

material conflicts of interest, and to hold themselves to a high degree of care, accuracy and 

fairness in dealing with both shareholders and companies by adhering to strict codes of 

conduct." 

IV. PROXY ADVISORY FIRMS HARM THE INTEGRITY OF PROXY VOTING BECAUSE THEY ARE 

SUBJECT TO CONFLICTS OF INTEREST 

The Society believes that proxy advisory firm voting influence undermines the integrity of 

the voting system for a number of reasons: (1) proxy advisory firms are subject to conflicts of 

interest; (2) proxy advisory firms make factual mistakes (sometimes material or egregious) in 

their analysiS, with the effect that their voting guidelines are erroneously applied to the 

company's proposal and the voting recommendation is inaccurate; and (3) proxy advisory firms 

have no economic interest in the shares they vote and therefore have no economic interest in 

the outcome. 

Proxy advisory firms are subject to four types of conflicts of interest. The first occurs as 

a result of proxy advisory firms selling services to both institutional clients and issuers. The 

second conflict arises when proxy advisory firms make favorable recommendations on 

proposals submitted by their own investor clients. The third conflict stems from proxy advisory 

firms' interest in recommending certain proposals that are likely to expand their influence and 

future market. The fourth may arise when an owner of a proxy advisory firm takes a position 

on a proxy voting issue and the firm also issues a voting recommendation on that issue (this 

applies to Glass Lewis only). 

A. Proxy advisory firms offer services to both institutions and issuers 

14 Lareker, McCall and Onnazabal at 43·45 

-9-
231 


81762.194

Most notably, ISS provides advisory services to issuers on corporate governance 

structures or compensation plans, and then makes voting recommendations based on the 

same structures and plans on which it has advised. Many Society members subscribe to ISS's 

service in an effort to ensure they design compensation plans that will get a favorable 

recommendation from ISS. Indeed, some Society members report that they believe they have 

no choice but to subscribe to ISS's service in order to gain sufficient visibility into the ISS model 

to understand what will gain a favorable ISS recommendation. 

The SOciety is aware that ISS believes its consulting services are walled off from vote 

recommendation decisions. Nevertheless, it appears that the consulting side uses the same 

compensation plan models that the analysts use when making voting recommendations. 

Accordingly, the Society does not believe this conflict can be adequately mitigated by "Chinese 

Wall" procedures between the consulting and voting sides of the business. 

It has long been the case that Glass lewis does not offer services or advice to issuers. 

However, this year, we have been made aware that Equilar, a service provider with whom 

Glass lewis has a financial relationship, is marketing its service to companies that receive a 

negative recommendation from Glass lewis. 

One large-cap midwestern company member received a call from an Equilar sales 

representative two business days after Glass lewis issued its report on the company which 

recommended against the say on pay proposal. The Equilar representative wanted to sell the 

company its consulting services so the company could learn more about the background of the 

Glass lewis recommendation. The Society member asked about the basis for the number Glass 

lewis had used for the CEO's compensation for 2012, as its CEO changed and Gl had used a 

composite of the former CEO's compensation and the new CEO's compensation. It was not 

clear to the company how Glass lewis had derived the number since it was about 45% higher 

than the amount reported in the summary compensation table for the current CEO. The Equilar 

sales representative was unwilling to discuss the number unless the company agreed to 

subscribe to the service, which was about $30,000. This same scenario was reported to us 

from other proxy solicitors and law firms. 

The Society is very concerned about the apparent conflict of interest. As one member 

put it: "After all the years of Gl criticizing ISS for taking consulting fees from corporate issuers, 

it seems that now they've adopted the same business model, except that the fees are 

laundered through Equilar." 

The Society notes that its members increasingly engage with their shareholders on 

various corporate governance and compensation matters-indeed in the say-on-pay world, 

companies are compelled to do so. Shareholders do not charge for this consultation. The 

Society believes that proxy advisory firms who are acting as voting agents for the institutional 

investors have a conflict of interest in charging companies for consulting services that the 

institutional shareholders themselves are providing free of charge. 

- 10-
232 


81762.195

B. Proxy advisory firms make recommendations on proposals submitted by their own 

investor clients 

Second, some proxy advisory firms make voting recommendations in favor of proposals 

that are being submitted by investors that are clients of the proxy advisory firm. The Society 

believes that the only way to mitigate this conflict is to require the proxy advisory firm to 

specifically disclose in their voting recommendation that the subject proposal has been 

submitted by a client-and for the client to disclose to the company and the other 

shareholders as part of its proposal in the proxy statement that the client utilizes ISS. We 

believe not having this information is harmful both to the other clients of ISS and to the 

company's other shareholders because, without this information, they have no idea of the 

extent of, or types of, conflicts to which the proxy advisory firm is subject. Corporate issuers 

and their shareholders have a right to know that they are subjected to voting 

recommendations that have been proposed and paid for by the proxy advisory firms' clients. 

C. Proxy Advisory Firms Have an Interest in Recommending Proposals that Sustain 

and Expand Demand for their Services 

Proxy advisory firms are in the business to make a profit. For this reason they must 

keep their services relevant, and necessary. This is clearer today since the say on pay vote has 

been mandated: "As so many predicted when Say on Pay was being debated, the outcome of 

mandatory Say on Pay advisory votes will be the ascendency of the proxy advisory firms' 

executive compensation models, whether or not the proxy advisors have any expertise or 

knowledge about executive compensation, whether or not their executive compensation 

metrics are well founded conceptually and fairly and accurately applied in practice and 

whether or not those metrics are at least more often than not applicable to specific companies 

facing specific issues in terms of management retention, management incentives and 

shareholder value creation.,,15 

Therefore, proxy advisory firms will make recommendations that will increase demand 

for the services they or affiliated companies offer to the same institutional clients. In such 

instances, the proxy adviSOry firm has a specific interest in the outcome of the vote on the 

issue. For example, annual-rather than tri-annual-say-on-pay votes increase the frequency 

of proxy voting for institutional investors, thereby increasing dependence on the proxy 

advisory firms. As another example, MSCI, corporate parent of ISS, has an interest in 

generating demand for its environmental services; at the same time, ISS provides voting 

recommendations on shareholder proposals that advocate expanded environmental 

disclosures, such as the Global Reporting Initiative. 

15 Nathan, Charles, Barrall, James D.C. and Chung, Alice, Sayan Pay2011: ProxvAdvisors on Course for Hegemony, 

New York Law Journal, November 28,2011 

- 11 -
233 


81762.196

Furthermore, ISS 2012 voting policies for 2012 "make clear that ISS views a favorable 

vote of less than 70% as an indication of sufficient investor concern with a company's executive 

pay policies to require that either the company take what ISS considers appropriate corrective 

action or face a potential withhold vote recommendation for some or the company's directors. 

In the ISS Say on Pay universe, the new 50% passing grade for Say on Pay is now 70%.,,16 

This is troubling when ISS alone has the ability to sway about 20% of the average 

company's vote (and Glass Lewis about 10%). A negative recommendation in year one can 

result in a forgone conclusion that in year two, it may take action against your board. Because 

they control 30%, they can recommend against say on pay and then withhold against a board 

the following year. Also, it sometimes happens that Glass Lewis recommends against a director 

with a low vote the previous year, when in fact that low vote was due to ISS against 

recommendations. 

D. Glass Lewis is owned by an Investor That May Take a Position on a Matter for 

which it then Makes a Recommendation 

There can be an appearance of a conflict of interest on the part of Glass Lewis because 

it is owned by an investor, the Ontario Teachers' Pension Plan, which itself engages in activism 

and takes positions in some proxy fights. While there is no evidence that OTPP exerts pressure 

on Glass Lewis to recommend in favor of its own agenda, the appearance of a potential conflict 

remains. This should be mitigated. 

V. PROXY ADVISORY FIRMS HARM THE INTEGRITY OF PROXY VOTING BECAUSE THEY TAKE A 

"ONE SIZE FITS ALL APPROACH" 

Proxy advisory firms often do not take into account the specific circumstances of the 

issuer, but instead follow a one-size-fits-all approach to their vote recommendations. Society 

members have reported situations where the proxy advisory firm recommended against a 

governance practice that had been approved in a prior vote by the company's shareholders--

thus disregarding the will of shareholders. As a corollary, proxy advisory firms do not base 

their recommendations on empirical evidence of what is beneficial to the capital markets or 

industry. 

VI. PROXY ADVISORY FIRMS HARM THE INTEGRITY OF PROXY VOTING BECAUSE THEIR 

REPORTS REGULARLY CONTAIN FACTUAL INACCURACIES AND GROSS ANALYTICAL ERRORS 

One of the major factors undermining integrity in the proxy voting system is that the 

recommendations of proxy advisory firms are at times based on mistakes of fact or gross 

16 Chuck Nathan, James D.C. Barrall and Alice Chung, Sayan Pay 2011: Proxy Advisors On Course for Hegemony, 

New York Law Journal, (Nov. 28, 2011) 

- 12-
234 


81762.197

analytical errors where the drafters of the reports "just don't get it."l1 Because the services do 

not release their proxy reports publicly except for high fees, even after the annual meeting is 

concluded, and because they place strict limits on sharing of reports, it is difficult to be precise 

on the quantity of misinformation and clearly poor analysis produced by the firms. The 

Society's survey results indicate that 65% of the respondents experienced--at least once--a 

vote recommendation based on materially inaccurate or incomplete information, or where the 

proxy advisory firm reported as fact information that was incorrect or incomplete. [Q 5) One 

quarter of those respondents experienced inaccurate or incomplete information on several 

occasions. For the respondents who found inaccurate information in a vote report, the proxy 

advisory firm did not correct the mistake 57% of the time. Furthermore, in 44% of the 

instances where issuers found mistakes the proxy advisory firm reviewed its recommendations 

but was unwilling to change the recommendation or factual assertion. In another 22% of the 

instances where issuers found mistakes, the proxy advisory firm was unwilling to reconsider 

the recommendation at all. 

This lack of accuracy harms both issuers and investors. Several Society members have 

informed us that in several instances their institutional investors were unaware of a mistake in 

a proxy advisory firm report or recommendation and stated to the issuer in private that had 

they known otherwise, their own votes would have been different. Other Society members 

from small or mid cap companies do not receive proxy advisory firm reports at all, and cannot 

begin to assess the basis upon which votes may have been made by their institutional 

investors. Moreover, Glass lewis does not make its vote recommendations available to issuers 

at all-so issuers have no idea when there are mistakes in a report unless their institutional 

shareholders or proxy solicitors inform them. At the very least, proxy recommendatian reparts 

shauld be provided to all issuers in advance to enable the issuer to check the factual accuracy of 

the report. Votes that are not based on actual facts are not informed votes. 

The Society believes that mistakes are made because the procedures utilized by proxy 

advisory firms are inadequate and not subject to review. We believe this is largely a cost and 

resource issue. Issuers note that the staff at proxy advisory firms seem overwhelmed during 

proxy season and do not appear to spend the appropriate time reviewing the issues in the 

context of the specific company nor in engaging in substantive dialogue with the issuer to 

discuss concerns they may have regarding a proposal. Moreover, much of the staff at proxy 

advisory firms appears to be junior, poorly paid in comparison with their investment manager 

clients, a nd to have limited experience. 

To illustrate the many concerns Society members have about the processes utilized by 

proxy advisory firms, we have collected a number of examples from our members, which are 

reflected (anonymously) in the Appendix hereto. The concerns fall into the following general 

categories: 

17 The best example this season was a Glass Lewis recommendation against a financial company's say on pay where 

it showed the company's 2012 earnings per share declining by 90% when in fact the opposite was true and the 

company had a very large increase in earnings per share. 

- 13-
235 


81762.198

Insufficient Time to Review and Comment 

In the minority of situations in which a proxy advisory firm offers an issuer an 

opportunity to review its draft report, the review period is very short (sometimes less than 24 

hours). For example, one Society member reported: "This year ISS gave us 17 hours to review 

and respond to their report on us this year, and 7 of those hours were between the hours of 

midnight on a Sunday and 7 am on a Monday." In several instances, ISS delivered the report 

immediately before Easter Sunday and required the issuer to respond that Monday. 

No Possibility for Review at All 

ISS does not permit most firms (any company not in the S&P 500 index) to review its 

reports before issuance. 

Glass lewis will not provide reports to any issuer [or otherwise engage with them 

except in limited, typically off-season, situations.] Companies that hire proxy solicitors usually 

get the report from their solicitor after Glass lewis has distributed it to investors. 

Alternatively, companies can pay a fee of either $3,500 or $5,000 for its own report. 

This year, the access to Glass lewis reports has become even more difficult and costly. 

Proxy solicitors have been told that their under the revised terms of the subscription license 

they can read their clients the reports over the phone, but they can't share copies of the 

reports with their clients. Instead, Glass lewis apparently expects issuers to either buy their 

own report, or use the Equilar "Governance Center" service that permits modeling and access 

to Glass lewis reports at a cost of up to $30,000. 

Infrequent Correction of Factual Errors by the Proxy Advisory Firm 

Even when the issuer points out factual errors upon which the recommendation is 

based, proxy advisory firms do not always correct the errors - much less change the 

recommendation. Thus, one Society member reported in 2010 that its report from ISS 

calculated its CEO's compensation as cash plus a "Guaranteed Bonus" when the CEO did not 

receive any guaranteed bonus. When the issue was raised to ISS, the analyst said that this 

metric was "hard-coded" and could not be changed. 

More recently, ISS and Glass lewis have both been more receptive to change factual 

errors, but only when the companies know about the errors and have time to correct them. 

Many times it is very late in the voting process. And again, for the small and mid-cap 

companies that do not see reports in advance and may not use proxy solicitors, the time 

between discovery of error and the company meeting can be very short to nil, if at all. 

Comparison to Irrelevant or Misleading Peer Groups 

- 14-
236 


81762.199

Inappropriate peer groups used by proxy advisory firms has been one of the most 

prevalent problems in recent years. Peer groups figure strongly in the two major proxy 

advisory firm's analysis of compensation issues, particularly say on pay. Both firms decline to 

use company peer groups, or to begin with those peer groups and subject them to critical 

analysis. Instead, they use less-costly approaches in assigning peer groups to all companies on 

a formulaic basis. 

Both firms have changed their methodologies in the last year, at least in part in 

response to criticism. In both cases, there appears to be improvement, but in the case of ISS 

the improvement appears to be limited and its application remains unclear. For example, 

Apache Corp. in a supplemental filing states that ISS chose a peer group that included nine 

additional companies, none of which are in the oil and gas exploration and production business 

and are "essentially opposite parts of the energy sector, the majority of them are significantly 

smaller than" Apache. Even worse, one of the ISS peers had a CEO who worked only six 

months rather than a year, but ISS failed to annualize the compensation. 

Failure to Change Recommendations after "corrections" 

One company noted in a supplemental filing that one of their directors was a member of a 

law firm. Their initial proxy disclosed that the law firm had done business with the company, 

but did not disclose the amount of fees involved as it was a minimal amount ($9,000). ISS 

recommended investors withhold support for the director. The company called ISS and 

explained that $9,000 was an immaterial amount. ISS told them if the amount was not 

disclosed, they assumed it was a conflict. The company then filed an amendment to proxy 

disclosing the amount. Nevertheless, ISS did not change the withhold recommendation. All of 

this happened within a very short time frame since the company is not an S&P 500 company 

and does not get an advance copy of ISS report. While the director was ultimately elected, the 

company had to incur the expense to deal with ISS recommendation, which turned out to be 

wasted effort. 

Misapplication of State law 

ISS does not always apply a company's applicable state law to its voting 

recommendations or procedures. For example, when ISS counts votes on shareholder 

proposals, it does not count abstentions. Yet, state law governs how votes must be counted. 

Shareholders can vote for, against, or abstain, on shareholder proposals. Many investors 

"abstain" and this often means they do not support the proposal, yet the abstentions are not 

counted by ISS. The result is that a proposal will "pass" under ISS's standard but not under 

state law (e.g. Delaware). We think the "votes cast" threshold should include abstentions in 

the denominator, which would make it consistent with the Delaware standard. Even for 

proposals that are only advisory, the state law should trump an arbitrary standard set by a 

proxy advisory firm. ISS's policies should be consistent with the applicable law governing 

shareholder rights. Not counting abstentions tips the scale to more shareholder proposals 

"passing." This is important particularly because ISS has indicated that beginning next year it 

- 15-
237 


81762.200

will take action against directors if a shareholder proposal "passes" and the company does not 

enact the proposal as ISS seems fit. In effect, they could be withholding support for a director 

even though a majority of the shareholders have not indicated their support for the prior 

year's proposal. 

VII. PROXY ADVISORY FIRMS HAVE NO ECONOMIC INTEREST IN THE OUTCOME OF THE 

VOTES THAT THEY RECOMMEND 

Proxy advisory firms do not have an economic interest in the companies in which they are 

making voting recommendations. The delegation by investment advisors of their vote to proxy 

advisory firms has resulted in a divorce between the persons who make the investment 

decision and the persons who exercise the vote. This gap makes clear that, as the proxy voting 

system currently operates, voting recommendations may bear no relation to the economic 

performance ofthe company-and therefore, such voting recommendations may not, in fact, 

improve the performance of a company. 

Because proxy advisory firms do not need to take into consideration the economic 

consequences of their recommendations, they do not feel compelled to specifically tailor their 

recommendations to the particular facts and circumstances of each issuer-and this, in turn 

only encourages the "one size fits all" approach currently seen in proxy advisory firm 

recommendations. 

Thus, the fact that investment managers (with fiduciary duties) can rely on proxy 

advisory firms (with no fiduciary duties) not only to make voting recommendations-but also 

to effect the vote itself-is a disconnect in the current system that must be remedied. As 

further discussed below, we believe persons with the economic and fiduciary responsibilities of 

share ownership need to exercise more responsibility in decision-making with respect to the 

voting process. 

VIII. PROXY ADVISORY FIRMS SHOULD BE REQUIRED TO IMPROVE THEIR PROCEDURES 

Proxy advisory firms should be required to change certain of their current procedures. 

The Society respectfully requests that proxy advisory firms be required to: 

• Establish procedures to manage conflicts of interest, and specifically disclose in their 

reports any and all conflicts of interest with the subject of their recommendation 

(e.g., as discussed above, by noting their relationship with proponents of the 

proposal) 

• Disclose the methodologies, guidelines, assumptions or rationales used in making 

their recommendations, including discussion as to whether the proxy advisory firm's 

methodology is a "generic methodology" applied to all issuers (i.e., is not specific to 

the facts and circumstance of a particular issuer) 

- 16 -
238 


81762.201

Disclose the processes used to gather their information, including how their 

reviewers are trained; the number of companies each analyst reviews within a 

given time frame; and whether or not the recommendations go through a "second 

review" process by a more senior manager 

• Provide ALL companies the reports in advance with at least 3 business days to 

review draft reports prior to their release to investors 

• Disclose the processes, if any, the proxy advisory firm has established to discuss 

their recommendations with an issuer prior to their release; and disclose whether 

the firm has an "appeals" process if the issuer disagrees with the recommendation 

• Include in their reports any response by the issuer regarding any factual matters or 

items the issuer has contested (we note this recommendation is also endorsed by 

the NYSE Commission on Corporate Governance), and include whether the issuer 

invoked an "appeal" of the recommendation (if the proxy advisory firm has such a 

process) and whether the proxy advisory firm revised its recommendation as a 

result 

• Report to the SEC at the end of each proxy season the number of incidents where 

issuers took exception to the factual statements contained in the proxy advisors' 

reports or appealed the recommendation of the proxy advisory firm 

• Disclose their executive compensation models and standards so that issuers do not 

need to purchase consulting services from a proxy advisory firm in order to 

determine if it will get a favorable recommendation on a stock plan 

The purpose of these disclosures and procedures is intended to make the processes and 

methodologies utilized by the proxy advisory firm more transparent, accountable and reliable. 

The goal is to ensure that proxy advisory firm recommendations are undertaken with more 

care, accuracy and fairness. 

IX. INVESTMENT ADVISORS AND PROXY ADVISORY FIRMS SHOULD BE SUBJECT TO STRICTER 

REGULATION 

Investment advisors and other fiduciaries, such as pension plans, have a fiduciary duty 

to vote the sh,!res they hold on behalf of their beneficiaries. As noted above, because of the 

volume of proxies needed to be voted each season, most investment managers outsource their 

voting responsibilities to proxy advisory firms. However, these proxy advisory firms are 

generally not required to also be registered with the SEC and, as they have no fiduciary duties 

to the shareholders on whose behalf they are making voting decisions, they have no 

responsibility to take into consideration how their recommendation will affect the economic 

value of the company's shares they are voting. 

- 17 -
239 


81762.202

The Society believes that both investment advisors and proxy advisory firms must have 

an affirmative obligation to ensure that vote recommendations are based on accurate facts, 

are given by providers free from conflicts of interest, and are in the best interests of 

shareholders. While conflicts of interest may be mitigated by "Chinese Wall" procedures and 

adequate disclosure by both the investment advisor and the proxy advisory firm, the Society 

notes that issues such as lack of accuracy and accountability, which are largely resource issues, 

are rooted in the economics of how proxy advisory firms are compensated for their services. 

The Society supports proxy advisory firms having adequate staffing to enable them to 

undertake a thorough review of the specific facts and circumstances of individual companies--

rather than merely following formulas and general guidelines. The Society believes, however, 

that without adequate and appropriate SEC regulation of proxy advisory services, there is no 

incentive for proxy advisory firms or the investment managers that hire them to provide the 

necessary resources to the system to ensure that vote recommendations are accurate and 

responsible. 

A. All Proxy Advisory Firms should be required to register as Investment Advisors 

An initial recommendation to improving the quality of the proxy voting system would 

be to require proxy advisory firms to become registered investment advisors. In this way, the 

practices and procedures of such firms would be subject to SEC examination. These 

examinations, we believe, would provide additional discipline and accountability to the system. 

Once registered, proxy advisory firms would need to establish to an oversight authority that 

they are following their procedures and would need to provide factual support for the bases of 

their disclosures (enhanced, as suggested above). 

However, the Society is not confident that registration of proxy advisory firms, in and 

of itself, will solve the issues noted above, particularly the "one-size-fits-all" approach now 

generally taken by proxy advisory firms with respect to their recommendations and votes. The 

Society notes, for example, that ISS is currently registered under the Investment Advisors Act 

of 1940, and it is not required to perform, as part of its services, an analysis of how each 

proposal for which it is giving a vote recommendation will or will not benefit the company's 

shareholders from an economic pOint of view. We therefore believe registration of proxy 

advisory firms is just the first step needed to correct the current system. 

B. The Special Treatment under the Proxy Solicitation Rules that Proxy Advisory Firms 

Now Enjov is Untenable 

The SEC should consider whether proxy advisory firms should also be brought within 

the regulatory constraints of the proxy rules themselves, through a requirement to file their 

recommendations as soliciting material. Many members of the Society believe that the vote 

recommendation is tantamount to soliciting a proxy. And while the proxy advisory firms may 

characterize their reports as "opinions," the fact that they issue recommendations on how to 

vote a particular item is no different than if a retail shareholder's broker gave a similar 

recommendation on how to vote. 

- 18-
240 


81762.203

The exemption currently available to the proxy advisory firms under Rule 14a-2(b)(3) is 

therefore inappropriate as applied to their business model. They characterize themselves as 

being in the business of giving individualized advice to those investors who subscribe to their 

services; however this is not true in practice since the recommendations have broad influence. 

The proxy advisory firms are able to function like the do because the market listens to them; 

Proxy advisory firm recommendations can move markets, especially in hotly contested votes, 

like proxy fights and mergers/acquisitions. Therefore, having made themselves an integral part 

of the proxy voting process, they should be required to abide by the same rules as all the other 

participants."8 

C. Investment Advisors Relying on Proxy Advisory Firms Should Oversee Their 

Recommendations and Analysis 

In addition to the registration of proxy advisory firms, any investment advisor or other 

fiduciary that relies upon or uses a proxy advisory firm should be required to exercise 

appropriate oversight of the proxy advisory firm and its recommendations. The entity that has 

fiduciary duties to its clients (who are the beneficial owners of the issuer's stock) should, at a 

minimum, ensure that the proxy advisory firm (who in fact is acting as the investment 

manager's agent) has processes and procedures in place that are responsible, auditable, 

accountable and transparent with respect to its voting recommendations. 

We therefore propose that the proxy advisory firm that is used by an investment 

manager be audited periodically by the investment manager to assess the quality of the votes 

cast on its behalf, including ensuring that the votes cast were consistent with the policies of the 

institutional advisor/fiduciary (if different from the proxy advisory firm). 

In addition, each investment manager or other fiduciary that utilizes the services of a 

proxy advisory firm should be required to disclose to its clients: (i) the name(s) of the proxy 

advisory firm it has engaged, and (ii) the extent to which the investment advisor/fiduciary has 

followed or not followed the recommendations of the proxy advisory firm. 

Most importantly, we would propose that each investment manager or other fiduciary 

that utilizes the services of a proxy advisory firm be required to establish procedures to ensure 

that by following the voting recommendation of the proxy advisory firm with respect to a 

particular company, the investment manager was acting in the best economic interests of the 

shareholders of such company. Only in this way will the total disconnect that currently exists 

between those who manage the economics of share ownership and those who determine the 

vote associated with share ownership be addressed and corrected. 

18 Wachtell Lipton Comment Letter to SEC RE: Concept Release on the US Proxy System (Release No. 34-62495: IA3052; IC-29340) dated October 19, 2010 at 7. 

- 19-
241 


81762.204

The purpose of the procedures and disclosures suggested above is not intended to limit 

the ability of investment managers and other fiduciaries in retaining the services or proxy 

advisory firms. Rather, the additional procedures being proposed are intended to provide 

discipline, accountability and oversight for the process by which proxy advisory firms develop 

and vote their recommendations, and the additional disclosures being proposed are intended 

to provide appropriate and necessary information to the relevant stakeholders (issuers and 

their shareholders, fund participants of investment managers, and clients of proxy advisory 

firms) of these processes and of any conflicts of interest that may exist between participants in 

the process. 

The processes and disclosures proposed above may become more applicable in light of 

regulations proposed on October 21, 2010 by the Department of Labor which, if adopted, 

would substantially broaden the definition of the term "fiduciary" under the Employee 

Retirement Income Security Act of 1974 ("ERISA"). One result of the broadened definition may 

be the inclusion within such term of proxy advisory firms, which firms would then become 

subject to the rigorous standards of conduct with which plan fiduciaries are charged under 

ERISA. Even if proxy advisory firms are not themselves brought within the definition of 

"fiduciary" under the proposed regulations, it is clear from the Preamble of the proposed rules 

that the DOL views investment advice as advice relating to "other property of the plan" 

including "advice and recommendations as to the exercise of rights appurtenant to shares of 

stock (e.g., voting proxies).',19 We note that this rule proposal was withdrawn and is expected 

be re-proposed this year. 

Consistent with the DOL's views as articulated in the proposed rules, the Society 

believes it is clear that investment managers need to be more responsible and take a more 

active role in supervising the voting recommendations of proxy advisory firms. Consistent with 

their fiduciary duties, investment managers need to be able to demonstrate that the vote cast 

in respect of a particular proposal for a particular company supports and helps maximize the 

economic value of the shares being voted. Only in this way will the disconnect between 

economic and voting power that currently exists in the proxy voting system be remedied. 

Summary 

As stated so" aptly by Larcker, McCall and Ormazabal above: "The obvious question that 

remains to be answered is whether or not the confluence of government regulations, the 

outsourcing of recommendations the proxy advisory industry, and responses by boards of 

directors to these recommendations, produces an increase in shareholder value as antiCipated 

by government regulators (SEC, 2003).,,20 We believe that the answer is no. But with 

appropriate oversight of proxy advisory firms, through additional regulation of both the firms 

and the investment managers that engage them, the system will be significantly improved, 

more transparent, and more accountable. 

19 Federal Register, Vol. 75, No. 204, Oct. 22, 2010 at 65266. 

20 Larcker study at 4. 

- 20-
242 


81762.205

We appreciate the opportunity to have commented on this important proposal and 

would be happy to provide you with further information to the extent you would find it useful. 

- 21 -
243 


81762.206

Citations and Sources 

Department of Labor Employee Benefits Security Administration, Federal Register, Vol. 75, No. 204, Oct. 

22, 2010, to be re-proposed 

Glassman, James K. and Verret, J. W., How To Fix Our Broken ProxvAdvisorySvstem, George Mason 

University, 2013 

International Business Machines, Comment Letter, Concept Release an the U.S. Proxy Seasan, October 

15,2010 

Larcker, David F., McCall, Allan L. and Tayan, Brian, And Then a Mirocle Happens: Haw Da ProxyAdvisarv 

Firms Develap Their Vating Recommendatians?, Stanford University Rock Center Closer Look Series, 

February 25, 2013 

Larcker, David F., McCall, Allan L. and Ormazabal, Gaizka, Outsaurcing Sharehalder Vating ta Proxy 

Advisary Firms, May 10, 2013 

Latham & Watkins, Future af/nstitutianal Share Vating Revisited: A Faurth Paradigm, September 2011 

Nathan, Charles (RLM Finsbury), Debunking Myths about Activist Investars, Harvard Law School 

Corporate Governance Blog, March 15, 2013 

Nathan, Charles, Barrall, James D.C. and Chung, Alice, Sayan Pay2011: Proxy Advisars an Caurse far 

Hegemany, New York Law Journal, November 28, 2011 

Nathan, Charles M. and Mehta, Parul, The Parallel Universes of Institutional Investing and Institutional 

Voting, April 2, 2013 

Securities and Exchange Commission, Final Rules: Proxy Vating by Investment Advisors, January 31,2013 

Society of Corporate Secretaries and Governance Professionals, Camment Letter: Cancept Release an 

the U.S. PraxySystem, File Na. S7-14-10 PraxyAdvisary Firms (Sectian VI, December 27,2010 

Wachtel!, Lipton, Rosen & Katz, Comment Letter to SEC RE: Concept Release on the US Proxy System 

(Release No. 34-62495: IA-3052; IC-29340), October 19, 2010 

22 -
244 


81762.207

STANFORD CLOSER LOOK SERIES 

Topics, Issues, and Controversies in Corporate Gov('rnance and Leadership 

And Then A Miracle Happens!: 

How Do Proxy Advisory Firms Develop 

Their Voting Recommendations? 

By David F. Larcker, Allen L McCall, and Brian Tayan 

February 25, 2013 

THE ROLE OF PROXY ADVISORY FIRMS 

Proxy advisory firms are independem, for-profit 

consulting companies that provide research and 

voting recommendations on corporate governance 

matters brought before investors at shareholder 

meetings. These matters include rhe election of the 

board of direcrors, approval of equity-based compensation programs, advisory approval of management compensation, and other management- and 

shareholder-sponsored initiarives regarding board 

structure, compensation design, and other governance policies and procedures. 

There are many reasons why investors might 

choose to consult with rhird-parry advisors when 

voting their position on these matters. Insritutional 

investors are generally required by the Securities 

and Exchange Commission to vote all matters on 

the corporate proxy and disclose their votes to beneficial owners of their funds. Given the size and 

diversiry of their holdings, it might be impractical 

for professional investors to have a thorough understanding of all items brought before them. Small 

investors, in particular, might not employ sufficiem 

analytical staff to review all proposals in detail. For 

these reasons, reliable and valid rhird-party recommendations can contribure to a well-functioning 

market by improving information flow between issuers and investors leading to better decisions on 

compensation and corporate governance. 

The proxy advisory industry in the United 

States is currently dominated by two major firms: 

Institutional Shareholder Services (ISS) and Glass 

Lewis & Co., whose clients manage $25 trillion 

and $15 trillion in investment assets, respectively. 

The research literature demonsnares the influence 

that these firms have over voting outcomes. Bethel 

and Gillan (2002) find that a negative recommendation from ISS on a management proposal can 

sway between 13.6 percent and 20.6 percent of the 

vote.' Cai, Garner, and Walking (2009) find that 

a negative ISS recommendation can influence 19 

percent of the vote.2 Research evidence also demonstrates the influence that proxy advisory firms have 

over the design of corporate governance policies. 

In a recem survey conducted by the Conference 

Board, NASDAQ and the Stanford Rock Center 

for Corporate Governance, over 70 percent of directors and executive officers report that their compensation programs are influenced by the policies 

or guidelines of proxy advisory firms.' 

For these reasons, the quality of proxy advisory 

recommendations is critical to ensuring that share w 

holders, corporate officials, and regulators make 

appropriate decisions regarding compensation and 

governance policies. 'The clients of proxy advisory 

firms need to be diligent in their evaluation of the 

policies of these firms to ensure that these policies 

are "accurate" and aligned with their interest to 

maximize long-term shareholder value.' Accurate 

recommendations are those that successfully differentiate between good and bad future outcomes. 

Negative recommendations from proxy advisory 

firms should be correlated with negative future 

outcomes (e.g., poor future stock performance, 

increased risk of accounting restatement, etc.) and 

positive recommendations correlated with positive 

future outcomes. 

POLICY DEVElOPMENT PROCESS 

To assess the accuracy of proxy advisory firm policies, we can evaluate both the process by which they 

are developed and their consistency with neunal, 

STANFORD CLOSER LOOK SERIES 
245 


81762.208

AND THEN A MIRACLE HAPPENS!: HOW DO PROXY ADVISORY FIRMS DEVElOP THEIR VOTING RECOMMENDATIONS? 

rigorous empirical research. Glass Lewis provides 

little information to the general public on the development of their voting policies. According to a 

Glass Lewis discussion paper: 

Glass Lewis' policies, taiwred for each market, 

are formulated via a bottoms-up approach that 

involves discussions with a wide range of market 

participants, including investor clients, corporate issuers, academics, corporate directors and 

other subject matter experts, among others. ?he 

process takes into consideration relevant corporate governance standards, company, local regulations and market trends. Policy changes and 

report enhancements are driven by such discussiom, as well as through consultations with the 

Glass Lewis Research Advisory Counci[5 

Moreover, Glass Lewis does not provide clarifYing detail on how general corporate governance 

concepts and standards are translated into codified policy. Without this information, it is difficult 

for investors to assess whether the process used by 

Glass Lewis leads to accurate recommendations. 

Institutional Shareholder Services discloses 

more extensive information than Glass Lewis does 

abeut the firm's policy development process. According to their website: 

[55 is committed to openness and tramparency in formulating its proxy voting policies and 

in applying these policies to more than 40,000 

shareholder meetings each year .. .. Our bottomup policy formulation process collects feedback 

from a diverse range of market participants 

through multipk channels: an annual Policy 

Survey of institutiolU11 investorY and corporate 

issuers, roundtables with industry groups, and 

ongoing ftedback during proxy season. ?he [55 

Policy Board uses this input to devewp its draft 

policy updates on emerging governance issues 

each year. Before jilU1lizing these updates, we 

publish draft updates for an open review and 

comment period! 

Patrick McGurn, executive director at ISS, contends that rhe firm's "multi-tiered process" helps to 

mitigate "unintended consequencesn by incorporating "fact-specific feedback" to shape final policies? 

Martha Carter, director of research at ISS, believes 

that "our commitment to this approach enhances 

rhe value of the research we deliver to clients.'" 

However, there are several issues in ISS' approach which raise questions about rhe accuracy of 

its recommendations. First, the ISS data collection 

ptocess relies on a very small number of participants. For example, ISS' most recent polic)' survey 

received responses from only 97 institutional investors.' 'This figure is down 69 percent from just four 

years ago.'u A sample of this small size is unlikely 

to identifY compensation and governance policies 

that should be applied uniformly to all publicly 

traded corporations." The decline in respondents 

is particularly troubling because it suggests that 

ISS is not successful in contacting participants or 

in convincing them of the value of their participation. It also raises the concern that more strident 

viewpoints might be over-weighted in the sample 

if strongly opinionated investors are more likely to 

participate. 

Second, the composition of the respondent 

pool that ISS does reach is not well disclosed. Although ISS provides descriptive statistics of the 

rypes of institutions that participate in the survey, 

rhe investment objectives of these investors is not 

clear (see Exhibit 1). This matters because assessing 

policy outcomes will differ depending on whether 

they are tailored to shareholder-centric investors or 

stakeholder-centric investors. As it is, there is no way 

to determine whether ISS' response pool is representative of shareholder groups broadly or instead 

reflects the opinions of a narrower set of activisrs, 

hedge funds, passive investors, etc. (In the survey, 

ISS asks respondents whether their organizations 

are "mission-based" but does not disclose the resulting statistics. See the bottom of Exhibit 1) 

Third, the survey suffers from design errors that 

are likely to confuse and/or bias respondents. For 

example, the ISS survey is flawed in how it frames 

certain questions and offers response choices (see 

Exhibit 2). These errors are important because they 

make survey results difficult to interpret and even 

more difficult to generalize into voting recommendations. Furrhermore, the ISS survey does not seek 

to establish the precise thresholds or conditions 

under which a recommendation (for" or "againse' 

STANFORD (lOSER lOOK SERIES 
246 


81762.209

AND THEN A MIRACLE HAPPENS!: HOW DO PROXY ADVISORY fiRMS DEVELOP THEIR VOTING RECOMMENDATIONS? 

will be triggered. Instead, the ISS survey uses vague 

qualifYing words such as "excessive," "problematic," 

and "significant" whose exact meanings are open to 

interpretation by the respondents. As such, it is difficult to understand how responses to these questions ultimately lead to concrete voting policy decisions (e.g., a negative say-on-pay recommendation 

will be triggered if CEO compensation levels are 

above [some specific thresholdj). 

Fourth, it is unclear how ISS incorporates the 

feedback that it receives during the open comment 

period to finalize voting policies. For example, ISS 

recently ptoposed a draft rule that would recommend investors vote against directors of a company 

that /ailed to act on a shareholder proposal receiving majority support during the previous year. ISS 

justified the rule by citing its policy survey results 

which found that "86 percent ofinstitutional invesror respondents expect that the board should implement a shareholder proposal that receives support 

from a majority of shares cast." It claimed that the 

rule would "strengthen its policy to hold directors 

accountable for failure to respond."l2 In a comment 

letter, Pfizer opposed the change and pointed out 

that the rule can run counter to a board's fiduciaty 

duries: 

The Policy runs the risk that Boards would be 

coerced to abdicate their fiduciary duties, which 

do not disappear or become less significant when 

a majority o/the votes cast at a meeting support a 

particular proposal. Boards should not feel compelled to act where they believe that such action 

is not in the best interests of the company. It certainly would make sense to disclose the Boards 

rationale, but an automatic vote against all directors is inappropriate and inadvisable. 13 

Similar arguments were made by executives 

at Ball Corporation, Eli Lilly, FedEx, Honeywell, 

and Principal Financial Group and by the Business 

Roundtable and the National Association of Corporate Directors (NACO).!' Still, ISS adopted the 

rule without specifYing the conditions under which 

it would defer to a board's judgment of what constitutes a correct action given its fiduciary duties. IS 

Finally the linkage between the opinions proxy 

advisors collect through the solicitation process 

and the policies ultimately enacted is unclear. ISS 

solicits investor and issuer sentiment on general 

concepts relating to board structure, compensation, and governance matters and then somehow 

translates this into codified policies. For example, 

the firm's most recent policy survey asked institutional investors their view on the practice of allowing executives and directors to pledge company 

stock as collateral for a margin loan. Forty-nine 

percent responded that any pledging of shares is 

"significantly problematic;" 38 percent responded 

thar pledging is concerning if it involves a "significant amount of shares;" and 13 percent responded 

that it is not a concern (see Exhibit 2 for the exact 

question and responses)." ISS cited these results in 

its 20 I3 policy document which was updated to 

recommend that investors vote against the election 

of directors of companies whose executives or directors have pledged shares, depending on the "magnitude of aggregate pledged shares in terms of total 

common shares outstanding or market value or 

trading volume."!? Left unspecified is the threshold 

above which pledged shares will trigger an "against" 

or "withhold" vote. ISS did not solicit this information in the policy survey, nor did it publish the 

results of rigorous empirical testing to demonstrate 

the levels at which executive or director pledging 

of shares has been reliably shown to reduce shareholder returns or amplifY enterprise risk. Without 

rigorous and transparent research, how can ISS ensure that its final policies are anything other than 

arbitrary? 

More broadly, ISS and Glass Lewis should demonstrate that they engage in testing to ensure that 

rheir final policies are accurate-Le., that they produce outcomes that are, on average, superior to the 

ourcomes observable under alternative policies or 

no policy at all. Since proxy advisory firms have 

the data used to make their recommendations, it 

should be easy for them to back-test results to verifY 

that their past voting recommendations were correct. 

A review of the research literature uncovers numerous instances where proxy advisory policies are 

either in conflict with research results or not directly 

supported by them. For example, research suggests 

that proxy advisory firm voting recommendations 

STANFORD CLOSER LOOK SERIES 
247 


81762.210

AND THEN A MIRACLE HAPPENS!: HOW DO PROXY ADVISORY FIRMS DEVElOP THEIR VOTING RECOMMENDATIONS? 

for management ~~say on pay" are not value enhancing but instead value destroying.18 Similarly, 

research suggests that proxy advisory firm voting 

recommendations for stock option exchanges also 

decrease shareholder value." To our knowledge, 

there is no research evidence to support ISS criteria 

for equity compensation plans or the firm's calculation of proprietary metrics such as the "annual 

burn rate" and "shareholder value transfer" which 

are used to determine whether shareholder dilution 

is excessive. In contrast, proxy advisory firm guidelines on other matters, such as certain anti-takeover 

protections, do have empirical support.2° 

WHY THIS MATTERS 

1. ISS claims tha[ its process for developing proxy 

voting guidelines is "open and transparent." 

However, a careful examination does little to 

clarifY the informadon they rely on in deciding 

to adopt a policy. How exactly do ISS and Glass 

Lewis determine that a policy is "correct?" How 

do they determine that a specific policy is in [he 

best intereS[ of shareholders? 

2. Proxy advisory firms obrain feedback from a diverse se< of market participants in [he policy formulation process. However, the most recent ISS 

survey conrained responses from only 97 instimtional investors. Who participates in the policy 

development process with bo[h ISS and Glass 

Lewis? How do we know that [hese participams 

validly rep res em the objectives and opinions of 

all market participams? 

3. Investors and corporate issuers often have very 

different perspectives on corporate governance 

matrers. How does ISS weigh these competing 

perspectives? Do they "favor" the investor perspective over the issuer perspective? If so, when is 

this approach justified and when is it not? 

4. Ultimately, the accuracy of a recommendation 

can only be determined by rigorous statistical 

analysis showing positive impact of a governance 

choice on shareholder value. What rigorous empirical research supportS each of the voting recommendations promulgated by proxy advisors? 

Why don't ISS and Glass Lewis disclose the specific research (either that they have conducted or 

conducted by third-parties) that justifies eacb of 

their recommendations? _ 

t Jennifer E. Bethel and Stuart L. Gillan, "The Impact ofInstitutional 

and Regulatory Environment on Shareholder Voting," Financial 

Managemmt (200:2), 

2 Jie Cai. Jacqueline J, Garner, and Ralph A. Walking, "Electing Directors," Journal of Finance (2009). 

3 1be Conference Board, NASDAQ, .and Stanford Rock Center for 

Corporate Governance, ~lhe Influence of Proxy Advisory Firm Vot~ 

ing Recommendacions on Say-on~Pay Votes and Executive Compen~ 

sation Decisions," (2012). Available at: http://www.gsb.stanford. 

edu! ddrl research! surveys/proxy.h tml. 

4 In a recent speech, former SEC Commissioner Daniel M. Gallagher 

warns of the potential problems that an arise from overreliance on 

the advice of proxy advisory firms. In particular, he emphasizes the 

need to ensure that their policies are accurate and free from conflict 

of interest: "It is important (0 ensure that advisers to institutional 

investors". are not over~relying on analyses by proxy advisory firms. 

We learned a significanr lesson about overreliance on the diligence 

of others in the run up ro the financial crisis, as investors and regulators relied on credit rating agencies with disastrous results. As with 

credit rating agencies, it is important for poHcymakers to understand, evaluate, and if necessary address the practices and business 

models of proxy advisory firms. Of particular interest should be ac~ 

countability for accuracy as well as potential conflicrs ()finrerest .... " 

See: Daniel M. Gallagher, "Remarks before the Corporate Directors 

Forum," Jan. 29, 2013, Available at: hnp;lfwww.sec.gov/news! 

speechJ20 13JspchO 12913dmg.htm. 

~ Glass Lewis & Co .• "Discussion Paper-An Overview of the Proxy 

Advisory Industry. Considerations on Possible Policy Options," 

Uun, 25, 2012). Available at: hnp:Jlwww.glasslewis.comJassers/ 

uploads/20 12/12/062 512_g1ass_Iewis~.comment_esma_.djscussion_papec vCpdf. 

6 ISS, "Policy Formwation and Application." Available at: http:// 

www.issgovernance.comfpolicyfprocess. 

7 Patrick McGurn, participant in; US Chamber of Commerce, «Ex~ 

amining the role of Proxy Advisory Firms," (Dec.5, 2012). Available 

at: hnp:!!www.uschamber.com/webcasts/examining-roleproxy-advisory-firms, 

8 ISS, "Institutional Shareholder Services Releases 20 l3 Proxy Voting 

Policies," (Nov. 16,2012). 

9 ISS, 2012-2013 Policy Survey Summary of Resulrs (September 

2012). 

!II RiskMetric.'i Group, 2008-2009 RiskM:etrlcs Group Poticy Survey: 

Summary ofReswts (October 2008), 

n ISS, Proxy AdVISOry Services (2013). Available at; http:// ...... ww.iss~ 

governance .coln/proxyl advisory. 

12 ISS, "Board Response to Majority-Supported Shareholder Proposals 

(U.S.). Available at: http://www.issgovern-ance.com/BoardResponse Maj ori ryShareholderPro posals20 13. 

13 Letter from Matthew lepore, Vice President and Corporate Secre~ 

ta.ry, Chief Counsel, Pfittr Inc (November 7, 2012). Available at: 

hrtp :llwww.issgo"\·ernance.com/files/Pfizerl n c •• p df. 

141SS, 2013 Draft Policies for Comment. Available at: http://www, 

issgovernance.com!policycomment20 13. 

1, Following the open comment period, ISS amended the final rule 

to include the condition thar "less than full implementation will be 

considered -on a case-by~case basis;" however, this qualific:ation raises 

more questions than it answers on how ISS will decide whether to 

defer to the board's judgment. See: [SS, U.S. Corporate Governance 

Policy, 2013 Updates (Nov. 16.2012). 

16 ISS, 2012-2013 Policy Survey Summary of ResultS (September 

2012), loc. cit. 

17 ISS, 2013 Updates, loco cit. 

STANFORD CLOSER LOOK SERIES 
248 


81762.211

AND THEN A MIRACLE HAPPENS!; HOW DO PROXY ADVISORY FIRMS DEVELOP THEIR VOTING RECOMMENDATIONS? 

!8 David E Larcker, Allan L. McCall, and Gaizka Ormazabal, ""The 

Economic Consequences of Proxy Advisory Say~on-Pay Voting 

Policies," Rock Center for Corporate Governance at Stanford University working paper (May 2012). Available at: http://ssrn.com/ 

abstract",21 0 1453. 

!, David F. wcker, Allan L. McCall, and Gairlca Ormazabal, "Proxy 

Advisory Firms and Stock Option Exchanges: The Case of Institu~ 

tional Shareholder Services," Stanford Rock Center for Corporate 

Governance at Stanfurd University working paper (Apr. 15,2011). 

Available at; hup:llssrn.com/abstract", l811130. 

20 Proxy advisory firm opposition to staggered boards is supponed by 

John Pound, "The Effects of Antil.1keover Amendments on Take~ 

over Activity: Some Dire.ct Evidence;" Journal of Law and Economics 

(1987); Lucian Arye Bebchuk, John C Coates IV; and Guhan Subramanian, "The Powerful Antitakeover Force of Staggered Boards: 

Theory, Evidence, and Policy," Stanford lAw Review (2002); and 

other papers. Proxy advisory firm opposirion to dual class shares is 

supported by Ronald W. Masutis, Cong Wang, aJld Fei Xie, ''Agency 

Problems at DuaJ~Class Companies." Journal ofFinanu (2009). 

David Larcker is the Morgan Stanley Director of the Center 

for leadership Development and Research at the Stanford 

Graduate School of Business and senior faculty member 

at the Rock Center for Corporate Governance at Stanford 

University. Allan McCall is a Ph.D. candidate in accounting at the Stanford Graduate School of Business and cofounder of Compensia, a national executive compensation 

consulting firm. Brian Tayan is a researcher with Stanford's Center for Leadership Development and Research. 

larcker and Tayan are coauthors of the book Corporate 

Governance Matters. The authors would like to thank 

Julian Ziatev of the Behavior Lab at the Stanford Graduate Schoo! of Business for his comments on qualitative 

research standards, and Michelle E. Gutman for research 

assistance in the preparation of these materials. 

The Stanford Closer Look Series is a collection of short 

case studies that explore topics, issues, and controversies 

in corporate governance and leadership. The Closer look 

Series is published by the Center for Leadership Devel~ 

opment and Research at the Stanford Graduate School 

of Business and the Rock Center for Corporate Governance at Stanford University. For more information, visit: 

http://www.gsb.stanford.edu/cldr. 

Copyright © 2013 by the Board of Trustees of the leland 

Stanford Junior University. All rights reserved. 

STANFORD CLOSER LOOK SERIES 
249 


81762.212

AND THEN A MIRACLE HAPPENS!: HOW DO PROXY ADVISORY F!RMS DEVELOP THE!R VOT!NG RECOMMENDATIONS? 

EXHIBIT 1 - ISS POLICY SURVEY: RESPONDENT PROFILE (2012-2013) 

More than 370 total responses were received. A total of 97 institutional investors responded. 

Approximately 71 percent of investor respondents were located in the United States, with the remainder divided between U.K., Europe, Canada, and Asia-Pacific. 237 corporate issuers responded, 

with 79 percent of them located in the United States and the remainder divided between U.K., 

Europe, and Canada. 

Notes: Size of institutional investors measured by equity assets under management or assets owned; size of corporate issuers measured by market capitalization. 

Results not reported to the question: "Is your organization a mission~based or socially~responsible investor?" 

Resu!ts also not reported to the question: "!s your organization a UN Principles for Responsible Investing {PRO investor 

signatory?" 

Source: ISS, 2012-2013 Policy Survey Summary of Results (September 2012). 

STANFORD CLOSER LOOK SERIES 
250 


81762.213

AND THEN A MIRACLE HAPPENS!: HOW DO PROXY ADVISORY FIRMS DEVELOP THEIR VOTING RECOMMENDATIONS? 

EXHIBIT 2 EXAMPLES OF QUESTION DESIGN flAWS 

The ISS 2012-2013 Policy Survey contains three types of question design flaws: 

1. The assumptions that frame some questions are not adequately defined. 

2. Some questions contain leading or biasing comments. 

3. Some questions contain response selections that bind respondents to mUltiple answers or to 

answers that might not match their opinion. 

Consider the following questions. 

Desig n flaws: 

The policy on "overboarded directors" is referred to but not provided. 

The term "excessive" is not quantified. 

The question binds respondents to mUltiple responses. E.g., an investor who believes that private company directorships should be included in the policy but not nonprofit directorships is 

not permitted to express this opinion. 

Design flaws: 

The heading "pay for failure" biases respondents that the termination packages in question 

are not merited. 

The terms "sizable packages" and "significantly lagging returns" are not quantified. 

The term "problematic" is vague. It could be interpreted to mean anything from a minor annoyance to a critical issue. 

The question is not clearly tied to a policy decision. 

STANFORD CLOSER LOOK SERIES 
251 


81762.214

AND TH~N A M!RACLE HAPPENS!: HOW DO PROXY ADVISORY FIRMS DEVELOP THE!R VOTING RECOMMENDATIONS? 

EXHIBIT 2 - CONTINUED 

Design flaws: 

The first sentence of the question biases respondents that pledging is negative. 

The scale is not properly structured. It does not sufficiently allow for moderate opinions. 

The second response combines different conditions. 500,000 shares is very different from shares 

representing 10% of a company's market value. 

The question is not clearly tied to a policy decision. 

The decision to use environmental or other sustainabllity-re!ated metrics is best 

left to the members of a compensation committee. Calls for use of such metrics 

constitute undue micromanagement of the executive pay process 

Calls for a board to adopt environmental or other sustainability-related metrk 

may be appropriate at companies where there have been significant problems in 

the past. A case-by-case approach is best suited to determining if the use of such 

metrics would benefit shareholders. 

Environmental or other-sustainability-related compensation metrics are 

appropriate tools for boards to use to focus executives on managing significant 

risks. Use of such relevant non~financial metrics in pay programs would benefit 

shareholders. 

Design flaws: 

27.9% 72.5% 

35.3% 19.6% 

32.4% 5.8% 

The question biases respondents that the adoption of these performance metrics is positive. 

The choices bind respondents to multiple answers. It is possible to agree with the first sentence 

of each but not the second. 

The question is not clearly tied to a policy decision. 

Source: ISS, 2012-2013 Policy Survey Summary of Results (September 2012). 

STANFORD CLOSER LOOK SERIES 
252 


81762.215

MERCATUS 

RESEARCH 

HOW TO FIX OUR BROKEN PROXY 

ADVISORY SYSTEM 

James K. Glassman and 1. w. Verret 

.~. MERCATUS CENTER 

.~. George Mason University 

Bridging the gap between academic ideas and real~world problems 
253 


81762.216

ABOUT THE MERCATUS CENTER AT GEORGE MASON UNIVERSITY 

THE MERCATUS CENTER at George Mason University is the world's premier 

university source for market-oriented ideas-bridging the gap between academic 

ideas and real-world problems. 

A university-based research center, Mercatus advances knowledge about how 

markets work to improve people's lives by training graduate students, conducting research, and applying economics to offer solutions to society's most pressing 

problems. 

Our mission is to generate knowledge and understanding of the institutions that 

affect the freedom to prosper and to find sustainable solutions that overcome the 

barriers preventing individuals from living free, prosperous, and peaceful lives. 

Founded in 1980, the Mercatus Center is located on George Mason University's 

Arlington campus. 

www.mercatus.org 

Copyright© 2013 by James K. Glassman., 1. W. Verret, 

and the Mcrcatus Center at George Mason University. 

AU rights reserved, 

MeTcatus Center 

George Mason University 

3351 Fairfax Drive, 4th Floor 

Arlington, VA 2220}-4433 

(703) 993-4930 

mercatus.org 

Release date: April 161 2013 
254 


81762.217

ABOUT THE AUTHORS 

JAMES K GLASSMAN served between 2007 and 2009 as US undersecretary of state 

for public diplomacy and affairs and as chairman of the Broadcasting Board of 

Governors. In April 2012, he was appointed to the Investor Advisory Committee of 

the US Securities and Exchange Commission. 

He was the principal financial columnist for the Washington Post from 1993 to 

2004, has written three books on investing, and is currently investing columnist 

for Kiplinger's Personal Finance. He was a senior fellow at the American Enterprise 

Institntefrom 1996 to 2008, where he specialized in economics and technology. 

Glassman has had a long career as a journalist and publisher, serving as president 

of the Atlantic Monthly, publisher of the New Republic, executive vice president of 

U.S. News £t WarldRepoTt, editor and co-owner of Roll Call, and moderator of two 

weekly public affairs television programs on PBS and one on CNN. He holds aBA 

from Harvard University and is the founding executive director of the George W. 

Bush Institnte in Dallas. 

The views expressed in this paper are his own and not necessarily those of any 

other institution, incJudingthe SEC and tl,e Investor Advisory Board. 

J. W. VERRET is a senior scholar at the Mereatus Center at George Mason University 

and an assistant professor oflaw at George Mason University Sc.hool of Law. As a 

member of Mercatus's Financial Markets Working Group, he regularly briefs congressional staff, members of Congress, SEC commissioners, and other financial 

regulatory agencies on financial regulation topics. 

Verret received his JD and MAin public policy from Harvard Law School and the 

Harvard Kennedy School of Government and then served as a law clerk for ViceChancellor John W. Noble of the Delaware Court of Chancery. Before joining the 

faculty at Mason Law, he was an associate in the SEC Enforcement Defense Practice 

Group at Skadden, Arps in Washington, DC. 

Verret has written extensively on corporate law topics, including a recent 

paper, "Delaware's Guidance," co-written with Chief Justice Myron T. Steele of 

the Delaware Supreme Court. His academic work has been featured in the Yale 

Journal onReguiation, ThelJusinessLawyer, theDelawareJoumal of Corporate Law, 

the University of Pennsylvania Journal afBusiness Law, and the Virginia Law and 

Business Review. 

Ve~et was selected by the Northwestern Law School Searle Center on Law, 

Regulation, and Economic Growth for a 2009-2010 Searle-KaufrnatUl Research 

Fellowship. 
255 


81762.218

i'/IERCATUS GUTER CEORGE t/IASON UN!VERSlTY 

ABSTRACT 

A RULE ENACTED by the Securities and Exchange Commission in 2003 required 

institutions to adopt and disclose policies for proxy voting that were intended to 

minimize conflicts between the institutions' interests and those of their shareholders. An SEC staff interpretation of that rule led to a result almost the opposite of the 

ruling's intent. Institutions could easily protect themselves from legal liability by 

shifting responsibility to proxy advisory firms, which acquired increasing power 

over corporate governance, to the detriment of shareholders. The rule resulted in 

outsourcing decision making to advisors witb little particularized knowledge and 

no incentive to maximize value. The proxy advisory firms themselves face the same 

conflicts of interest that the rule was intended to minimize. The problem is compounded by a market for proxy advice that is dominated by two firms. To fix this 

broken system, itis necessary to return the responsibiIity to determine the need for 

a vote to shareholders and directors. 

JEL codes: Gl, G2, G3 K2, and L2 

Keywords: proxy advisorY firms, shareholders, hedge funds, mutual funds, 

Institutional Shareholder Services, Securities and Exchange Commission 

4 
256 


81762.219

I. BACKGROUND 

A DECADE AGO, the Securities and Exchange Commission (SEC) voted to 

require that every mutual fund and its investment adviser disclose "the 

policies and procedures that [they use] to determine how to vote proxies" 

-matters put to a vote by the public companies whose stock the fund holds-and to 

disclose votes annually.' 

The idea behind Rule 206(4)-6 and Rule 30bl-4, which were enacted on August 

6,2003,' was to "encourage funds to vote their proxies in the best interests of shareholders" and to avoid conflicts of interest between those shareholders and the fund's 

"investment adviser, principal underwriter, or certain of their affiliates.'" 

The SEC rule followed changes at the US Department of Labor (DOL) in the 

1980s mandating that ERISA pension plan fiduciaries-such as union, corporate, 

and other officials who control or manage a plan's assets-vote the plan's shares 

on the basis of active analysis, regardless of whether or not the fiduciary was 

certain that expending time and effort to analyze how to vote would create value 

for a fund.4 

The vast majority of shareholder elections are uncontested, and the vast majority of shareholder proposals are unsuccessful. As a result, it has been argued that 

aetively participating in shareholder elections, shareholder proposal votes, or 

other proxy votes may not be worth the effort for pension or mutual funds in lieu 

of other strategies (such as abstaining or passively voting in favor of management 

1. SEC, "Securities and Exchange Commission Requires ProxyVoting Policies, Disclosure by 

Investment Companies and InvestInentAdvisers,," press release, January 1, 2003, http://www.sec.gov 

/newsJpress/2003~12.htm. 

2. "SEC Brings Second Case AiJeging Improper Proxy Voting by an Adviser,.. Rop'es & Guy. May 20, 

2009, http://www,ropesgray.comjintech/. 

3. SEC, "Proxy Voting,Po1icies." 

4. "ERIS.I\. 3(16) Fiduciary Plan Administrator OVerview," ING Financial Services, accessed April 4. 

2.013, ing.us/file_./S399/fiduciary_erisa..3.....l6-PlarLadmin..overview.pd( 
257 


81762.220

MERC!','!US CEHTER P,T Cf:JJRC.,[ t"\r'\SON UNj\jERS!T'i 

recommendations unless specific circumstances requir~ more scrutiny).s But the 

Department of Labor ruled otherwise. In a key 1988 document called the "Avon 

Letter/' DOL stated that "the fiduciary act of managing plan assets which are shares 

of corporate stock would include the voting of proxies appurtenant to those shares 

of stock.'" The SEC eventually followed suit. 

A few months after the adoption of the SEC~s rule, one of the SEC commissioners, 

Paul.f,..tkins, expressed his relief that "the rule did not impose a (one~size-fits-all' 

requirement for the WTitten proxy voting procedures. Instead, we left advisers with 

the flexibility to craft suitable procedures. "7 

Unfortunately, the rrue became a classic case of unintended consequences. 

Many institutional investors largely outsourced their shareholder voting policies 

to a proxy advisory industry that relies on precisely the type of j(one-size-fits~all" 

policies that were intentionally excluded from the original regulation because of 

objections by commissioners. The SEC staffinterpretation of the rules on proxyvoting have led to the opposite result of what maay ofits supporters intended. Instead 

of eliminating conflicts of interest;. the rule simply shifted their source. Instead of 

encouraging funds to assume more responsibility for their proxy votes, the rule 

pushes them to assume less. Instead of providing informed, sensitive voting on proxies, the incentive has been to outsource decision making to two small organizations 

that most investors have never heard of. These two firms have emerged as the most 

powerful force in corporate governance in America today, shaping the way that 

mutual funds and other institutions cast votes on proxy questions posed by about 

5,000 US public companies. 

The larger of the firms, Institutional Shareholder Services (ISS), was founded in 

1985. When the Department of Lab or issued its new mandate a few years later, ISS 

made a specialty of advising institutional investors on how to comply with it,S and 

the firm has since profited from the demand created for its services by the government's requirements. 

5. David Yermack, "Sharehold.erVoti.cgand Corporate Govemnnce," Annual Review {)/Financial 

Eetmomic.s 1 (December lOW} 30, doHO.1l46!annurev-financiaI-07~OO9-104034. Passive voting strategies are distinguished from abstentions. Companies need to obtain a quorum of shareholder participation 

even in an uncontested vote to have asuccessful board election, merger approval, etc, and so passively 

voting shares can still be a valuable exercise. 

6. Allan Liebowitz:, letter to Helmuth Fand~ February 23, 1988, dted in '/A Call for Change in the 

Proxy Advisory Industry Status Quo," Center on Executive Compensation (J anullry 2011): 17, http!/! 

online..wsj.com/public./resourcesjdocument-:/Pro)"},AdviS<lryWhitePaper02072011,pdf. 

7. "Speech by SEC Commissioner; Remarks at the Investment Counsel Association ofAmerlc~" 

Commissioner Pau1 S.Atkins, SEC, April 11,2003, http://'iVV<''\v.sec.govjnews!speech/spch041103psa..htm. 

8. "25fur25: Observations on the Past, Present~ and :Future of Corporate Governance In Celebration of 

ISS' 25th Anniversary;' ISS (2011): iv, http://www,rhsmith.umd.edu/cfp/pdfs..docs/.commentary/ISS.pdf.< 
258 


81762.221

fi,ERC,A.TVS CEI\,Tt:R .AT GEORGe r,,\:\.':>ON UN!VERSIT'{ 

Proxy season is now underway. More than half of US annual meetings, where 

proxies are tallied, take place in April, May, or Jl1ne.9 In 2010 the SEC issued a "concept release" that caned for an examination oftheentire US proxy system, inc1uding 

#the role and legal status of proxy advisory firms."lO No action has been taken on the 

release, but with a new SEC chair moving into office a reexamination of the issue 

could be imminent. This report lays the groundwork for that cOl1sideratiolL What 

remains to be seen is whether the SEC will address a system that is badly broken 

and, most of all, hurts the small shareholders it is supposed to help. 

The authors do not hastily rush for a regulatory solution to all corporate governance challenges. We recognize that on most issues shareholders have a plethora 

of nonregulatory tools available, including self-funded proxy fights, taking short 

positions, pricing corporate governance quality at firms into trading activity, and 

suing a company in state court for breach of fiduciary duty by a director or officer. 

We want to be cIear~ Good corporate governance is crucial to the long-run success of any publicly traded company, and even the most aggressive defenders of 

capitalism agree that the participation of shareholders in proxy voting on governance issues can be an appropriate practice. In a recent report, the US Chamber of 

Commerce lauded l'policies thatpromote effective shareholder participation in the 

corporate governance process. Strong governance is a critical cornerstone for the 

healthy long-term performance of public companies and their positive promotion 

oflong-term sharehQldervaIue.'1ll 

But for the problem created by government rules that have enshrined two small 

proxy advisory firms, shareholders do not have anonregulatory solutiolL We argue 

that as long as proxy advisors hold regulatory preferences and a regulatory mandate 

that funds purchase their services, more regulatory-attention to the conflicts posed 

by these proxy advisors is wise. The remainder of this paperwill sketch the specific 

problems that should be addressed and OUT approach to resolving them. 

9. "A dialogue v.rith Institutional Shareholder Services," Audit CoTl1l:nittee Leadership Network in 

North America,. ViewPQints, no. 139 {November 7, 20l2}: 1, https://webfonns.ey.comjPublicationjvwLU 

AssetsjProxy_advisory-..fums/$FILEjViewPoints-39..NavemberJOlLDialogue...with..lSS.pdf. 

10. Concept Release on the U.S. Proxy System, SEC. 75 Fed. Reg. 42,981. 43,009 (July 22,. 2010). 

Comments on the conceptrelea .. e can be found at http:! jwww.sec..gov/oornments/s7~14~1O/s71410.shtml 

n, US Chamber's Center for Capital Markets Competitiveness, "Best Practices and Core Principles for 

the Development,. Dispensation, and Receipt of Proxy Ad\-rice," March 2013, http://www.ceoteriorcapital 

markets.com/wp~content/upload$/2010/01:(Best~Pracdces-and-Core-Princ.iples~fur-Proxy-Advisors.pdf, 

7 
259 


81762.222

f,,1.E-RCATUS CENTER AT GEORGE MASON Ui'lIIJ[R5IfY 

II. THE SOURCES OF ADVISORS' POWER 

OF THE TWO firms that dominate the proxy-advisory business, the larger by far is 

ISS with a 61 percent market shareP The second is Glass, Lewis & Co., LLC, with 

a market share of about 36 percent.u ISS is owned by MSCI Inc., a New York Stock 

Exchange-listed company that maintains dozens of stock and bond indices and provides portfolio management analytics for investment firms. Glass Lewis is owned by 

the Ontario Teachers' Pension Plan Board, which manages a fund with more than 

$100 billion in assets. These two principal proxy advisors have inherent conflicts 

not simply in their ownership but also in the services they provide to clients. Proxy 

advisors also have ShOVo(ll a tendem;ytoward ideological bias in their recommendations, especially in areas that involve labor union power, executive compensation, 

and the environment. 

The power of the two firms has increased in recent years for several reasons. 

First, mutual funds have become a larger force in investing, especiaUywith the rise 

of defined-contribution pension plans. Institutional stock ownership has risen from 

47 percent of assets of the 1,000 largest public corporations in 1987 to 76 percent just 

20 years later." Overall, mutual fund assets have risen nearly 3D-fold since 1987, and 

total shareholder accounts have quintupled." 

Secondl shareholder activism "y well-connected groups-particularly unions 

and environmental organizations-has sharply increased In addition. the Supreme 

Court's recent decision in Citizens United v. FEC'-~ opened up new avenues for corporate spending in elections, spurring current debates about whether shareholders 

should be able to approve such expenditures aod whether corporations should be 

12. A study by the US Government Accountability Office in 2007, "Corporate Shareholder Meetings: 

Issues Relating to Firms That Advise Institutional Investors.on Proxy Voting;" found that between them, 

ISS and Glass Lewis had more than 1,000 institutions (mutual funds and other financial finns) as clients, 

with $4().5 trillion in equity assets. Institutions served by the next three largest proxy-advisory finns 

had just $1.1 trillion in assets. See GovernmentAccountRbility Office, Corporate Shareholder Meeti~~ 

ISSI1f!1l Relating to Firms That Advise InUUutional Investors on Proxy Voting, tlReport to Congressional 

Requestt!rs, GA0-07-765 (Washington, June 2007):13, http!I/~,gao.gov/newJtems/d07765.pd{ 

13. Tamara C. Belinfanti, "The Proxy Advisory and Corporate Governance Induslly:: The Case fur 

Incre.asedOversight," StanfoTdJoumal of Law, Business ft Finan.ce 14 (Spring 2009):395. The author. 

an associate professor at New York Law School, attached the comment to a letter filed with the SEC on 

October 20,2010. See http://www.sec..gov/comments/s7~14-1O/s7141o-183.pd£ 

14. "A Call for Change in the Proxy Advisory Industry Status Quo," Center on EXecutive Compensation 

(January 2011): 15-16, http://online.wsj.cQ:m!public/resources/documentsjProxyAdvisoryWhitePaper 

02072011.pdf. 

IS. "~012 InyesttneI;1t Company Fact Book: A ReviewofTren.d.<l and Activity in the U.s. Investment 

Company Industry,'" Inyes.tInentCompany Instirute (20U): },34, http://~-wjd.Drg/pdfI20l2 

Jactbook..pdf. 

16. 558 U.S. 310 (2010). 

17. James R Copland,. Yevgeniy Feyroan, and Margaret O'Keefe, ''Prm..-y Monitor 20U; A Report on 

Corporate Governance and Shareholder Activism" (Fall lOU): 19, http://proxymonitor.orgJpdf/pmr 

-'><I.pdf. 
260 


81762.223

required to disclose them." New rules either proposed or approved by the SEC are 

making it even easier for such measures to be added to proxy ballots by shareholders." 

As a result, proxy proposals by shareholders are on the rise, according to a 

November 2012 "Shareholder Activism rnsight Report" from the law firm Schulte, 

Roth & Zabel, polling corporate executives and shareholder activists: 

Corporate executives should expect to see increasing opposition 

from shareholders during next spring's proxy season, according 

to the 78% majority of overall respondents. Using poor financial 

performance and the need for management or operational change 

as motivation~ hedge funds, pensions and unions will continue the 

growth of shareholder activism. A significant increase in shareholder proposals will result, according to 84% of respondents." 

The principal legislation that resulted from the 2008-09 crisis, the Dodd-Frank 

Wall Street Reform and Consumer Protection Act, 2(1 adds to the importance OfPTOXY 

voting by mandating that companies with a public float greater than $75 million conduct periodic (in most cases, annual) "Say-on-Pay" (SoP) votes." While those votes 

are nonbinding, they are taken seriously by corporate directors, not least because 

lawsuits could ensue if shareholder preferences are ignored. The SoP mandate was 

expanded this year to include 1,500 smaJIer reporting companies.22 

More institutional ownership, a trend toward activism, and the Dodd-Frank legislation have all enhanced the power of proxy advisors. But an even more important 

factor was how the original 2003 SEC rule was interpreted by SEC staff. In a staff 

letter responding to a request from Egan-Jones, a small proxy finn, the SEC advised 

on May 24, 2004: 

An investment adviser that votes client proxies in accordance 

with a pre-determined policy based on the recommendations ofan 

lB. See Stephen choi, JiJ1 Fisch. and Marcel Kahan, "The Power of Proxy Advisors: Myth or Reality?," 

EmDryLawJnumal S9 (20lO): 872-77,listiogreasons for the increased in shareholder power, including 

the elimination of broker discretionary voting and th.e movement from plurality to majority and nonstaggered boards; M A Call for Change in the Proxy Advisory Industry Status Quo," Center on Executive 

Compensation (January 2011): 5-6, http;//online.wsj.com!public!resources!rlocuments/ProxyAdvisory 

WbitePaper020nOlLpdf. 

19. Marc Weingarten, U20l2 Shareholder Activism Insigbt Report." The Harvard Law School Forum on 

Corporate Governance and Financial Regula.tion (blog), November 26, 2012, https:/jblogs.law.harvard 

.edu!cnrpgov/20UJn/26J2012-shareholder-activism-insight~report/. 

20. "Implementing the Dodd-Frank wall Street Refonn and Consumer Protection Act," SEC, lastmodi~ 

fied February 14, 20l3, http://www.sec.govJspotlightfdoddMfrankshtml. 

21. SEC, "SEC Adopts Rules fur Say~n-Pay and Golden Parachute Compensation as Required Under 

Dodd-Frank Act," press release, January 25, 20n, http://v;ww.se<:.go-v!news!pres,<;/2011!20ll-2S.htm. 

22. "Proxy Advisory Bu.siness~ Apotheosis or Apogee?," Corporate Governance Commentary, Latham & 

watkins LLP (March 2011): 2-3, http://www.lw.comjupload!pubContent/_pdf/pub4042J.pdf. 

9 
261 


81762.224

r\:~EHC/\TUS (EhiTER AT GEORGE N\A5ION UN1\lERSIT\' 

independent third party will not necessarily breach its fiduciary 

duty of loyalty to its clients even though the recommendations 

may be consistent with the adviser's own interests. In essence, the 

recommendations of a third party that is in fact independent of an 

investment adviser may cleanse the vote of the adviser's confIict23 

In other words, if an independent proxyadvi'ioryfinn recommends a proxy vote, 

thep. the mutual fund and its adviser can foHow that recommendation and avoid a 

claim that it has a conflict of interest. A second important interpretation was that 

mutual funds and their advisers had to vote all their shares on aU proxy issues on the 

basis of actively developed policies." Overall, US issuers pose more than 250,000 

proxy questions ayear, and it is not unusual for large mutual funds and their advisers 

to be required to cast votes on more than 100,000 of them on the basis of actively 

developed voting policies. 

Bypayingfees to proxy advisors, funds and their investment advisers could avoid 

being sanctioned by the SEC or being sued successfully by lawyers representing 

shareholders unhappy with particular proxy votes." A 2011 study by the Center for 

Executive Compensation quotes Leo E. Strine Jr., vice chancellor of the Delaware 

Court of Chancery, saying, "Fol1owing ISS c.onstitutes a form of insurance against 

regulatory criticism, and results in ISS have a large sway in the affairs of American 

corporations.)'26 For the proxy advisors, the SEC's actions produced a bonanza of 

revenues-and of political power. Suddenly ISS became, as one recent report put it, 

"the de facto pay and governance police. '>27 

The Egan-Jones letter helped ISS in another way. Part of ISS's business was 

advising listed firms eissu-ers," in the parlance of regulators) on corporate governance, including recommendations on how to win proxy votes. While, on the face of 

it, this may seem to be a conflict, the SEC letter explicitly said that it was not. 

23, "rnvestment Advisers Act cfl940-Rule 206(4)-6: Egan-Jones Proxy Services," SEC letter to Kent 

S. Hughes, May 27, 2004, http://www.sec.govjdivisionsjinve;s:t;ment!noaction/eganOSl704.htm. 

24. The SEC's proxy policy rules have been interpreted to include. a mandate to vote shares 011 the basis 

~f aetively developed policies. S~e- Concept Release on the u.s. Proxy System, SEC, 75 Fed. Reg. 42,981. 

43,009 (July 22,. 2010). 

25. There are exceptions. In 2009, the SEC brought a complaint against rNTECH Investment 

Management:. LLC. alleging that the finn tried to curry favor with the AFL-ClO by adopting an ISS 

proxy-votingplatfurm thatfoUowed the voting recommendations of the union. INTECH's aim, accorning 

to the SEC, was to improve its score onan annualAFL-CIO survey ranking investment advisers. A total 

of $350,000 in fines was assessed. Sec Order Instituting Administrative Cease-and~Desist Procee-dings 

Pursuant to Sections 203(e),203(f) and 203(k) of the InvestmentAdvi~s Act 0(1940, MaJdngFindings 

and Imposing Remedial Sanctions and a Cl!ase-a..'l.d-Desist Order, File No. 3+13463 (M:ay I, 2009), available at http://\llww.sec.govjlitigation!admin/1OO9jia-2872.pdf. 

26. Leo E. Strine,Jr., "The Delaware Way. How We Do Corpo,ate Law and Some of the New 

Challengt'.s We (And Europe) Face," DdawareJournal a/Corporate Law 30 (2005): 688. 

27. "A Call for Change in the Proxy Advlsory Industry Status Quo," Center on Exeeutive Compensation 

(January 2011); 15-16, http:/ jonline:.wsj.com/public/resources/documectsjProxyAdvisoryWhitePaper 

020nOlLpdf. 

10 
262 


81762.225

1\,\ERCf\TUr::; Cf>JTFR J!.,T GEORG£ Mi\S0N UN\VERS\T';' 

In your letter, you ask whether a proxy voting firm would be 

considered to be an independent third party if the firm receives 

compensation from an issuer eIssuer') for providing advice on 

corporate governance issues. We believe that the mere fact that 

the proxy voting finn provides advice on corporate governance 

issues and receives compensation from the Issuer for these services generally would not affect the firm's independence from an 

investment adviser.28 

Ill. THE DEPTH AND BREADTH OF ADVISORS' INFLUENCE 

IN 2003;W. James McNerney Jr., then chairman of 3M Corporation, statedinalet~ 

ter to the SEC thatISS controlled the proxy votes of half of his company's shares and 

that "many of the top 30 institutional shareholders we contacted in each of the past 

two years to discuss our position would riot engage in any meaningful discussions1 

often citing adherence to ISS proxy voting guidelines.1'~9 

The McNerney letter was referenced in a study of proxy advisors published in the 

Stanford Journal of Law, Business, and Finance.30The study also cited Lynn Stout of 

Cornell, who wrote, {'\Vhen institutional investors follow ISS [proxy recommendations] en masse, directors of public corporations can expect to see 20%, 30% even 

50% of their company's shares being voted not as the directors recommend. but as 

ISS recommends."U 

Of course, no single institution det~rmines the outcome of every proxy vote, but, 

according to a study by David F. Larcker, Allan L. McCall, and Gaizka Ormazabal, 

opposition by a proxy advisor results in a "20% increase ill negative votes cast."-ll 

That figure underestimates the power ofISS and Glass Lewis since corporations tryingto avoid a negative recommendation from a proxy advisory firm will shape their 

policies accordingly. Another study, published by researchers Jennifer E. Bethel 

and Stuart L. Gillan in the journal Financial Management, found that when ISS 

28.. "Investment Advisers Actof1940-Rule 206(4)~6: Egan-Jones Proxy Services," SEC letter to Kent 

S. Hughes, M.ay 27, 2004, http://www.secgov/divisions,linvestment/noaction/egano52704.htllL 

29. "Comment from W. James McNery, Jr, on SEC Proposed Rule," SEC, December S, 2003, http:// 

~-w.sec.gov/ruleslProposed/s1l903/3m120503.htm.. 

30. Tamara C. Belinfanti, "The Proxy Advisory and Corporate Governance Industry: The Case for 

Increased Overs.ight," Stanford JiJtlmal of Law, :Business, and Finance 14 (Spring 2009): 386-87014. 

31, Ibid. 

32. Da,,1i1 F. Lanker, Allan L McCaU, and Gaizka OTmazabal. "The Economic Consequences of Proxy 

Advisor Say-on-Pay Voting Policy" (Rock Center for Corporate Governance at Stanford University 

Working Paper No. 119, Stanford, CA, 2012), http://Papers.s.s:m.com/so13IPapers.cfm?abstracud;;:; 

2101453. 

11 
263 


81762.226

rAERCA1US C£NlER GEORGE: fl".A::'ON UNIVER.5iT,' 

recommends a "no" vote on a management proposalt affirmative votes decline ~y 

13.6 percent to 20~6 percent. 3J 

Between them1 ISS and Glass Lewis clients control 25 percent to 50 percent of 

the typical mid-cap or large-cap company's shares, accordingto a study by a proxy 

solicitation finn.3.j. Members of the Society of Corporate Secretaries and QQvemance 

Professionals "think that ISS alone controls one-third or more of their shareholders' votes:~15 

Last year a survey conducted by the Conference Board, NASDAQ, and the 

Stanford University Rock Center for Corporate Governance reported research demonstratingthe influence that proxy advisory firms have over the design of corporate 

governance policies. Over 70 percent of directors and executive officers reported 

that their compensation programs were influenced by the policies or guidelines of 

proxy advisory firms.36 

To a large degree, corporate directors and executives are now subjectto decision 

making on critical issues by organizations that have no direct stake in corporate 

perlormance.and make poor decisions as a result Conscientious shareholders. who 

do have such a stake, also suff~ because their votes are usurped or overwhelmed by 

these same organizations. The SEC's proxy policy-rules have led to results unimag~ 

ined by their original advocates. 

Instead of mutual funds assuming more responsibility for their proxyvotes, they 

have assumed less. Instead of providing more incentive for informed, sensitive voting on proxies, the incentive has been to outsource decision making to firms that, 

for understandable business reasons, make their recommendations using one-size~ 

fits-all standards. 

The problem is compounded because, as a result of the financial crisis, Congress 

and the president have decided to give shareholders more authority over directorsand that means more authority for proxy advisors, who pJay a key role in determining how shareholders vote. As Strine wrote, "The influence ofISS and its competitors over institutional investor behavior is so considerab1e that traditionalists will be 

33. Stumt Gillan and Jennifer E. Bethel, "The Impact of the Institutional and Regulatory Environment 

on Shareholder Voting," University ofDe!aware Working Paper No. 2002~002, Newark, DE, 2002. 

http://papers.ssm.~om/so13/papers.cfm?abstract.id'"'354820. 

34-. Yin Wilczek, ''Bounty Program to Cramp Corpornte Boards: ABA Speakers Discuss G<lvemance 

Provisions," Daily Report for Ex~eutives. BloDmberg BNA, Aug. 10, 2010, cited in "A Call for Change in 

th~ Proxy Advisory Iudustry Status Quo," Center on Executive Compensation (January 2011): 20, http:// online.wsj.com/pubJic/resourcesjdocuments/ProxyAdvisoryWhitePaper020n011.pdf. 

35. Quote from Sus!W E. Wolf, fonner ehair of the Society, dted in «A Cal} for Change in the Proxy 

Advisory Industry Status Quo," Center on Exeeutive Compensation (January zon): 20, http://onIine 

.wsj.com/pllblic/resollrces/documentsjProxyAdvisory\VhitePaper02072011.pdf 

36. The Conference Board, NASDAQ. and Stanford Rock Center for Corporate Governance, "The 

Influence of Proxy Advisory Firm Voting Recommendations onS8.y-on~PayVot.es and E.'xecutive 

Compensation Decisions;' (March 2012), http://www.gsb.stanford.edu/cldr /research/surveys 

/prol.'Y.html 

12 
264 


81762.227

fvIERC!\TUS C(!\iTER .t>.T GEORGE rv'\f,SON UNlVER51T { 

concerned that any initiative to increase stockholder power will simply shift more 

clout to firms of this kind."" 

The victims of the unintended consequences are America's investors. As we shall 

see, research shows that rather than being enhanced, shareholder value is being 

depleted by the recommendations of proxy advisors because of inadequate professional standards,'conflicts ofinterest, alack of properly aligned incentives, ideological bias, or some combination of factors. 

IV. SUSPECT ADVICE AND SHAREHOLDER VALUE 

REGULATORS HAVE HANDED a valuable franchise, a franchise that lets them determine the shape of corporate governance in America, to two proxy advisory firms. 

If the decisions these firms make are good ones-that is, if they promote good governance and thus enhance shareholder value-the concentration of power might 

not be so troublesome. In that case, even in the absence of a regulatory mandatet 

institutions miglit wantto make use of proxy firms. The key question is, How good 

is the firms' advice? 

The objective of strong corporate governance is to enhance shareholder value, 

but it is by no means clear that ISS and Glass Lewis have achieved this objective with 

their recommendations. In fact, two serious studies found the contrary. 

A July 2012 Stanford study titled "The Economic Consequences of Proxy Advisor 

Say-on-Pay Voting Policies" looked at ISS and Glass Lewis recommendations on 

compensation policies and issued these stark conclusions; 

First~ proxy advisory firm recommendations have a substantive 

impact on say-on-pay voting outcomes. Second, a significant number offinns change their compensation programs in the time period 

before the furmalshareboldervote in a manner consistent with the 

features known to be favored by proxy advisory firms apparently 

in an effort to avoid a negative recommendation. Third; the stocie 

market reaction to these compensation program changes is statistically negative. Thus, the proprietary models used by proxy advisory 

firms for say-on-pay recommendations appear to induce boards of 

directors to make choices that decrease shareholder value.as 

37. Leo E. Strine Jr., "'Toward a True Corporate Republic: A Traditional Response to Lucian's Solutions 

for Improving Corporate Ametka, .. (John M. Olin Centerfor"Law. Economic:s and Busmess Discussion 

Paper Series, Paper 541, Harvard Law School, cambridge. MA, 2006), http:/;1sr.nelko.orgjh.arvard 

_-olin/54!. 

38. David F. Larcker, Allan L. McCall. and Gaizka Ormazabal, "The Economic Consequences of Proxy 

Advisor- Say~on-Pay Voting Policy'" (working paper, Rock Center fOT Corpor;ate Governance at Stanford 

University Working Paper No.. 119, Stanford, CA,. 20U): Abstract, http://papers.ssrn,(,,om/so13/papers 

.cfm?abstracLid=210145J. 

13 
265 


81762.228

:\'\ERC:\TUS CEi\ITER AT GEORGE M.A,~ON UHIVERSlT',' 

Specifically, the researchers found that, in their study of a total of more than 2000 

firms, the "average ri.'lk-adjusted return" on the implementation of the recommendations ~(is a statistically significant -0.42%."l~ 

In another Stanford study, in 2011, researchers looked at exchange offers-that 

is, transactions in which executives holding stock options are allowed to trade them 

in for new options. These offers (also called "re-pricing") typically occur when the 

original options the executives were granted are trading far out of the money and are 

unlikely to be worth much, if anything, in the future, thus destroying the incentive 

that options are supposed to produce. 

Certainly, exchange offers .can be abused, but whether to issue them is a subtle 

question that has no simple, uniform solution. StiH, ISS has taken a strong stand on 

limiting exchanges. For example, it issues negative recommendations on exchanges 

in which executive officers or directors can participate or when new options vest 

in six months or less. 

The study looked at 272 exchange offers and found that only 23 percent were 

compliant with ISS guidelines. This was a rare instance in which ISS's policies were 

not particularly influential, but it turned out better for shareholders that ISS was 

ignored. The researchers observed <ta positive price reaction to [all] exchange offers, 

suggesting that shareholders view these proposals as value-increafiing." In addition, 

uthe stock price reaction is significantly less positive when the exchange offer is 

constrained to meet ISS guidelines. " The authors also found that Ufuture operating 

perfonnance is lower and executive turnover is higher when the exchange program 

is constrained in the manner recommended by Iss.n.w Thus, the authors found that 

shareholders experienced better returns if they ignored ISS. 

Shareholders do not always ignore ISS's policies in instances where they harm 

companies. An example is ISS's policies concerning the new Say-on~Pay voting 

mandate. SoP was immensely popular among state pension and union pension 

funds. Notably, no representatives from the mutual fund or hedge fund conununity 

were active in the debate over SoP, which one would expect if the practice created 

value for shareholders."l The focus that proxy advisors place on SoP votes may stem 

39. IbiJ,4. 

40. David Larcker, ''Do ISS Voting Recommendations Create Shareholder Value?" (Rock Center for 

Corporate Governance at Stanford University. Closer Look Series: Topics,Issues and Controversies in 

Corporate Governance and Leadership No. CGRP-13. Stanford, CA, April 19. 2011): 2,. http://papers.ssrn 

.comJso13/papen;.cfm?abstracUd=IB16543##. 

41. At a Senate hearing at which one of the authors testified on this issue, the five-person panel included a representative from the American Federation of State, CQunty and Municipal Employees, a powerful union, and one from the Council ofInsritutional Investors, a pension fund group controlled by state 

and union pension funds. Notably, no representatives from the hedge fund or' mutual fund lobby were 

present or pnrticular-Iy supportive of pushing the rule forward at the SEC. The absence ofhedge fund or 

mutual fund support indicates that SoP may be about political issues. rather than a focus on shareholder 

returns. See Hearingon Protecting Shareholden andEnhancing PlIblicConfidence by ImprovingCorporate 

GovemanceBefore the Senate Cammittee on Banking, Housing, a- UrbanAffairs,lllth Congo (July 29, 

2009), hnp:/fwww.banking.senate.gov/publk/llldex.cfm?Fuseaction=Hearings.Hearing&Hearing 

JD"'c754606c~Ob9S-4139-a3Ba~63e63b4b3fa9. 

14 
266 


81762.229

;\/tERCfl.TU'::. CE1HER /\T GE:ORGE r\!if\~ON UN1VERSIl Y 

more from conflicted interests in pleasing particular types of clients than in recommendingvalue~enhandng voting policies. 

ISS requires that the board obtain the votes of at least 70 percentofsharcholders 

for its compensation plan, but the proxy advisor provides no evidence to. support 

that arbitrary requirement. Nor does ISS show how SoP votes themselves encourage more efficient compensation policies. ISS also universally recommends annual 

say-on-paY1(otes-again, with no empirical support. \Vhat SoP votes do encourage 

(despite the fact that they are not technically binding) are lawsuits." 

ISS also backs other corporate governance policies for which the empirical evidence is mixed, at best, but which nevertheless enjoy support among politically 

motivated institutional investors. Current ISS policies indicate support for independent directors,H and the firm indicates it will support, on a case-by~case basis, 

proposals to give shareholders the right to nominate director candidates to the corporate proxy, despite evidence suggesting that proxy access generally fails to add 

value.H ISS guidelines also indicate opposition to options repriCing, as we noted.~s 

The evidence on all of these issues is mixed~ at best. 

ISS supports independent chairs," but the literatore is unclear on whether having a chairperson separate from the CEO correlates with increased returns.47 Golden 

parachute agreements, which ISS opposes, are actually associated with increases 

in stock prices.4S Similar critiques have been raised with respect to independent 

'42. SsrahA. Good, Cindy v. schIaefer, and Ana N. D.amol'lte. "Proxy Season :arings Third Wave of 

'Gotcha' Shsreholder Litigation." PillsburyLaw.com, February 21, 20ll, http://\V'WW,piUsburyiaw.com 

jpublic.ations/proxy.season-brings-a-third-wave·of~gotcha-shareholder-litigstion. 

43. This paragraph dese:ribes JXllides contained in ISS's most recent policy statement for the 2013 

proxy 5eSlSOn. See "2013 U.s. ProxyVotingCnncis.e Guidelines/'ISS (December 19. 2012), http://www 

.issgovernance.coro/fiIl!SjlSS2013USConC':iseGuidelines,pdf. 

44. See Thomas Stratmann and 1. W. Verret,. -"Does Shareholder Proxy Access Damage Share Value in 

Small Publicly Traded Companies?, It Stanford Law Review 64 (20ll): 1431-68. 

45. The debate over whether (Jptions repricing is material to executive compensation packages is 

explored in Brian 1. Hall and Thomas A, Knox, "Underwater Options and the Dynamics of Executive 

Pay-to-Perlonnance Sensitivities,'" Jcnunal at AccountingReseareh 42, no. 2 (May2004): 365-412. 

46. See gena:aUy Roberta Romano, FoundatiDns ofCDrporate .Law, 2nd ed. (New York: Thomson 

ReutersjFoundation Press, 2010) 410-25. . 

47. See, e.g., PauIaL. Rechner- and Dan R. Dalton, "'CEO Duality and Organizational Performance: A 

Longitudinal Analysis," Strategic Management Journal 12, no. 2 (February 1991} 157. See also Audra L. 

Boone et at, "The Determinants of Corporate Board SiZe and Composition: An Empirical Analysis," AFA 

2005 Philadelphia. Meetings, Philadelphia, P A. March2006. http://dx.doi.org/10.2139/ssnt.605762. See 

also "Comment from Fidelity Invesb:nents on SEC Proposed Rule," SEC, March 18, 2004, http://www 

,sec.gov/rulesjproposedjs70304/£delity031804.htm, 

48. See generally RichardA. Lambert and David F. Lucker, "Golden Parachutes, Executive Decision 

Malcingand Shareholder Wealth," Journal fJf Accollntingand Economics 7 (1985). 

15 
267 


81762.230

i,,~ERCAl us. CaHER ,~T GEOR.GE ,\I\.i\50N UNJVER51T'{ 

directors. 'If,! The jury is also still out on takeover protections that have been consistently opposed by ISS and Glass Lewis.so 

More research is needed to establish with a strong degree of cerwntywhether 

proxy advisory recommendations consistently increase shareholder value. A 

problem with conducting such research is the lack of transparency on the part of 

the proxy advisors. A Conference Board survey related to advisory firm SoP recommendations concluded: 

While the evidence suggests that companies are aware of and react 

to proxy advisory policies as theyrehte to SOP, the evidence does 

not speak to whether these changes are positive or negative for 

shareholders. Until proxy advisory firm methodologies are vetted 

by third~party examiners. it cannot be determined whether these 

changes are beneficial to companies and their shareholders.s1 

Such third-party examinatiolis will be difficult, if not impossible. As a Rock Center 

commentary stated: 

Ultimately, the accuracy of a recommendation can only be determined by rigorous statistical analysis showing positive impact of a 

governance choice on shareholder value. What rigorous empirical 

research supports each of the voting recommendations promulgated by proxy advisers? Why don't ISS and Glass Lewis disclose 

the specific research (either that they have conducted or conducted 

by third parties) that justifies e""h of their recommendations?" 

49. Sanjai Bhagat and Bernard S. Black. '"The Uncertain RelatioJlshlp Between Board Compl)Sition and 

Firm Perfonnanc:e," Bw:in£S$ Law 54, no. 3 (May 1999)! 932. 

50. Barry Baysinger and Henry Butler, to Antitakeov~ Amendments, Managerial Entrenchment, and the 

ContractuaJ Theory of the Cnrporation," VirginillLaw Review n (198sr.1302-3. See also Marcel Kahan 

and Edward Rock, "'Col'p(lnte Constitutia:naiism: Antitakeov:er Cbarter Provisions as Pt'ecommitment," 

PenmyI'IIlmia Law Review 152 (2003): 515. . 

51. The Conference Board, NASDAQ, and Stanford Rock Center for Corporate Governanc:e, "The 

Influence of Proxy Advisory Firm Voting Recommendations on Say-oD~PayVotes and ExecutiVe 

Compensation Decisions'" (March 2012): 6, http://www.gsb.stanford.edu/ddr/research/surveys 

/proxy.hbnl 

52. Dav:id F. LllIc.ker, Allan L. McCall, and Brian Tayan, aAn~ ThenaMiradeHappens!HowDoProX)" 

Advisory Firms DeVelop Their Vo-ting Recommendations?" (Rock Center fur Corporate Governance at 

Stanford University Closer Look Series:. Topics, Issues and Controversies in Corporate Goveman~e and 

Leadership No. CGRP-3J, Stanfor-~ CA. 2013), http://papers.5srn..:om!so13/papers.cfm:?abs"tract 

..id=2224ll9. 

16 
268 


81762.231

V. TWO SOURCES OF LOW-QUALITY ADVICE 

THE EVIDENCE STRONGLY suggests that proxy advisors do not enhance shareholder 

value with their recommendations. It is time to examine why. The problem begins 

with a simple fact: proxy advisors lack the resources to make adequate judgments. 

Currently, ISS has 1,300 clients and covers more than 40,000 meetings and every 

holding within dientportfolios in more than 100 developed and emerging markets 

worldwide." ISS does all this with a research staff offewer than 200 persons." The 

other major advisor} Glass Lewis, says that it (fempower[s] institutional investors 

to make sound decisions by uncovering and assessing governance, business, legal, 

political and accounting risks at more than 23,000 companies in 100+ countries" 

with a total of just 300 employees, on1y 200 of whom are involved in research.55 In 

addition, more than half of company shareholder meetings occur in a three-month 

span (April to June),56 and this concentration makes thoughtful evaluatio~s even 

more difficult. 

A perverse outcome of the current system is that regulators are effectively sepa~ 

rating the evaluation of corporate governance from investment analysis.by driving 

funds to use crude alternatives to assess proxies, rather than the analytic exper~ 

tise that they tout as their comparative advantage. A 2010 report published on the 

Harvard Law School forum found that 

at best, they may rely on statistical modeling in an effort to sort 

portfolio companies by performance, such as grading a company 

against a peer group determined by SIC codes or the like .. ,. Voting 

decision makers do not and cannot utilize the tools of investment 

decision makers because it is simply not feasible to do so in the 

cost environment in which proxy advisors and internal corporate 

governance staffs are required to operate. 57 

53. "Proxy Advisory Services," ISS. -accessed Aprll4, 2013, http://www.issgt)ve.rnance:.com/D-TOXY 

/advisory. 

54. "A dialogue with Institutional Shareholder Services," Audit C<lmmittee Leadership Network in 

North America, ViewPoints, no. 139 (Novemher 7, 2012): 6, https:j/webfonns.ey.comjPublicationj ... ·wLU 

Assets/Proxy.....a.dvisol'YJinns/$FILE/ViewPoinls....39~ovember.....2012....Dialogue....w:ith...JSS.pdf, 

55. "About Glass Lewis," GlassLewis.com, accessed April 4, 2013, http://www.glasslewis.com/about 

~gi.ass~lewis/. 

56. EtA dialogue with lnstitutional Sbareholder Services," Audit Committee Leadership Network in 

North America, VieWPoints, no. 139 (November 7, 2012): 6, https~/ jwebf.onns.ey.com!publkationjV"wLU 

Asset .. jProxy..advisoryJirms/$FILE/ViewPoints....39....NovembeT....20ll..Dialogue....wiiliJSS.pdf. 

57. Charles Nathan., "The parnlle-] Univ.erses of Institutional Investing and Institutional Voting," The 

Harvard Law SchoDl FOl"Um Dn Corporate. Governance and Financia.l Regulation., April 6, 2010, http:// 

blogsJaw.harv.ard.edu/c:orpgovj20l0j04/06/the-parallel-univer5e5~oMn5titutional-investing-and 

-institutional-votingf· 

17 
269 


81762.232

On February 19 of this year, the Norges Bank Investment Fund (NBIF), the 

world's largest sovereign wealth fund ($650 billion), released a report questioning the application of one·~size-fits-all universal codes for evaluating corporate 

governance.58 The NBIF report concluded that ('principles should be seen as best 

practices and that considered deviation must be expected and welcomed." The 

implication is that the models used by proxy advisors are no substitute for informed 

analysis that considers the mission and background of each individual fund an~ 

looks carefully not just at rules and guidelines but also atthe real~life nature of each 

proxy question. 

An especia11y egregious example of the current reliance on guidelines and models 

involves Warren Buffett, perhaps the most respected investor and corporate leader 

of the past 40 years, a man brimming with experience and integi-ity. His company, 

Berkshire Hathaway, first bought Coca-Cola shares in 1988 and had amassed $10 

billion worth of stock, making Coke at the time its largest single investment. Buffett 

had long served on the audit committee of the board. 

But in April 2004, ISS opposed Buffett's reelection because some ofBerkshire>s 

companies, like Dairy Queen, sell Coke products, thus creating what ISS saw as a 

conflict. Accordingto an ISS press release, "The recommendation is based on ISS's 

best practice corporate governance guidelines that call for completely independent 

audit committees."59 

Buffett was reelected to the board anyway, and he commentedt «I think it's absolutely silly .... Checklists are no substitute for thlnldng."'" We do not suggest that 

it is necessarily wrong to focus on conflicts of interest on audit committees or otherwise; however, we do suggest that ISS's failure to consider Buffett's history with 

the company, his stature, and the firm's own compliance with rigid New York Stock 

Exchange listing rules for audit committee membership indicate a recommendation 

process that is unsophisticated and ~'one size fits all." 

Checklists are precisely what the regulators have encouraged. For example, ISS 

guidelines state that the firm will recommend voting againSt directors of a company 

that does not act on a shareholder proposal that received a majority of votes in the 

previous year:~it This sort of checklistitem, of course, means that Sol' "precatory." or 

advisory, votes actually carry the authority of being nearly mandatory. More importantly, the checklist item fails to take into account the possibility that directors may 

58. Norgi:s Bank In-vestment Management, NEIM Discussion Note! Corporate governance, November 

19, 20U. http://www.nbim.no/GlobaljDocumentsjDicussion%20Paper/20U/DiscussjonNote....l4-.pdf. 

59. ISS, "'Institutional Shareholder Services' Response to Coca-Cola Dhecror: HerbertAllen's April 15 

Wall Street J(lurnai OP'"Ed Misses Point .on AuditPaneJ Independence at CoOke," PR N ewswire, April1S, 

2004-, http://www.prnewswi:re.com/news~releasesftnstitut:ional~shareholder-services:-response-to 

-t<Ka~cola~dire-et{)r-724-9li527.htmt 

60, David Larcker and Brian Tayan, COrpDrate Glrvernance Matter.>;;A Closer Look at Org.1.nizational 

Choices and Their Consequences (New Jersey; FT Press, 2011), 403. 

6L See ISS guidelines referenced in note 43 on page IS. 

18 
270 


81762.233

have more information or wisdom trum shareholders, or that events have occurred 

in the interveningyear that supersede the original vote. It is telling that ISS is willing 

to make that generalized recommendation in the absence of clear evidence whether 

the underlying successful shareholder proposal will add value atthe eompany. 

In addition, ISS toughened some ofits standards in 2013, giving shareholder votes 

even more weight. According to an article in a trade publication, uThe finn will now 

consider a proposal to have gained majority support if it wins a majority of shares 

cast, not just a majority of shares outstanding, That's a significant change, since 

many shareho1ders never cast their votes."6Z 

The problem with checklists is that they simplify the complexities of business 

reality, Consider the matter of ISS's reHance on determining appropriate compensation by linking it to what a company's peer group members are paying. Company 

A may be on the ropes because a CEO just died or the company is simply performingpoorly. The pool of top CEOs in the industry may be tiny, and competitors may 

be grabbing market share. Company A's directors may believe that hiring away 

Company B's CEO will both hurt a competitor and help Company A in a time of dire 

need, and to get B's CEOto move may require doubling his or her salary and offering 

substantial stock options. Such nuances occur in real life but not on the checklists 

ofISS and Glass Lewis. 

Besides a lack of resources, proxy advisory firms lack the right incentives to 

make decisions that meet the interests of shareholders. As a working paper from 

the University of Pennsylvania School of Law states, 

Proxy advisors do not have a financial stake-in the-companies about 

which they provide voting advice; they owe no fiduciary duties to 

the shareholders of these companies; and they are not subject to 

any meaningful regulation. Moreover, it is not clear that the proxy 

advisory industry is sufficiently competitive and transparent to 

subject advisory firms-ISS in particular-to substantial market 

discipline.'" 

By contrast, the same paper points out that directors have powerfulincentives to 

make the right decisions. They own shares in their companies. they are subject to 

lawsuits, and they risk their personal reputations. The danger is that "boards may 

do what they believe ISS wants them to in order to keep their seats, whether or not 

their beHefis justified."64 

62. Joseph McCafferty. "Proxy Advisers MueCbanges to Voting-Guidelines fo.2013;" Complittnce 

Week, December 7, 20U. http://www.complianc:eweek.com/proxy-advisers-make-changes-to-voting 

-guidelines-for-2013/article/271784/. 

63. See Stephen Choi. Jill Fisch, and. Marcel Kahan, "The Power of Proxy Advisors: Myth or Reality?:' 

Emory Law Journal 59 (2{)lO): 872. 

64. Ibid. 

19 
271 


81762.234

MERCATUS CENTER .AT GEORGE MASON UNiVt:.R'5iT;' 

VI. THE ADDITIONAL PROBLEM OF CONFLICTS OF INTEREST 

WHEN THE SEC adopted its rule requiring mutual funds to disclose their proxyvoting policies, Chairman Harvey Pitt emphasized that the principal motivation for 

the new rule was his concern about potential couflkts of interest that mutual fund 

advisors face in voting their shares. He noted: ("Because the securities are held for 

the benefit of the investors; they deserve to know the fund's proxy voting policies 

and whether they were in fact followed. Many wield voting power in the face of 

conflicts; they may cast votes furthering their own interests rather than those for 

whom they vote."65 

Conflicts of interest deserve considerable discussion. Let's begin by looking at 

the results of poor advice under similar circumstances at credit~rating agencies.'56 

Federal regulators have designated nine firms as "nationally recognized statistical rating organizations.'.>67 One of the key functions of these NRSROs is to determine 

the creditworthiness of corporate and governmentborrowers and of specific bond 

issues. Two private firms dominate the market, though not quite as thoroughly as 

ISS and Glass Lewis dorrunate proxy advice. The two are Standard & Poor's, which 

according to the most recent SEC survey accounted for 44,500 of the 99,286 ratings 

of corporate issuers in 2010, and Moody's, which accounted for 30,285. Between 

them, the two firms accounted for 75 percent of the market for corporate bonds.; a 

third firm, Fitch, added another 14 percent. S&P and Moody's had an even larger 

share-83 percent-of the market for rating g~vernment securities, with Fitch 

accounting for nearly all the rest." 

An array of financial regulations requires banks, insurance companies, and other 

institutions ~lto use credit ratings to establish investment risk standards for their 

portfolio holdings,"" for example, to meet capital requirements. After the financial 

crisis of2008-09, credit~rating agencies, with 'conflicts of interest similar to proxy 

advisory firms, came under criticism for underestimating the risk involved in assetbacked securities, which they also rate (S&P and Moody~s controlled 73 percent 

of that market in 2010; Fitch, another 21 percent). On February 5 of this year, the 

6S. "Speech by SEC Chainnan: Remarks at the commission Open M.e~ting,'" chairman Harvey L. Pitt,. 

SEC, January 23, 2003, http://www.sec.gQv/news/speech/spehOl2303hlp.htm. 

66. Editorial, "Standard & Poor's Stand..~ Accused," New Yof"k Times, February 5,2013, http://www 

.nytimes.com/2013/D2/06/opiniQn/stllI1dard~poors-stands-acc\L'ied..html 

67. "Annual Report on Nationally Recognized Statistical RatingOrganizations," SEC (March 2012): 6-7, 

https:/lwww.sec.gov /divisions/marketregfratingagency jnrsroannrep03U.pdf. 

68. Ibid .• 9-10 

69. Ibid., }5. 

20 
272 


81762.235

MERCr\TUS CEiHLR .AT GEORGE rv'v\,SON UNlvERSlT.' 

Department of Justice brought suit against S&P, charging that severe harm was 

inflicted on investors.'o 

The problem was not simply that credit-rating firms misjudged risk (either 

innocently or because of conflicts of interest) but that-just as 'With proxy advisoryfirms-regulators conferred substantial evaluative powers on a few firms, thus 

enabling institutions that engaged those firms to pass offresponsibility for exercising their own fiduciary duty to conduct an informed analysis of the suitability of 

securities held in client accounts. 

Proxy advisors don't literally or legally have the same license as credit-rating 

agencies, but their oligopoly is eerily similar. The fear now is that the regulations 

that have empowered a few proxy advisers are leading to the same adverse ~esults 

as the.rules that have empowered a few rating agencies.?t 

Remember that the main purpose ofthe 2003 SEC rule on proxies was to address 

problems caused by conflicts ofinterest between institutions aJ)d the shareholders 

whose assets they manage. In fact, the conflicts have merely been shifted to different 

firms. The conflicts have actually been exacerbated by the rule, since their regulatorymandate gives proxy advisors substantial market power. Before the 2003 ruIef 

competitive pressures were already encouraging some mutual funds to disclose 

information about their proxy voting policies to customers. 72 Now those competitive pressures are Jess effective. 

There are two major ki.nds of conflicts of interest that afflict proxy advisors. 

The first is that advisors may beinfluenced by some of their largest clients to make 

reconunendations that serve those clients' social and political interests. As James 

R Copland of the Manhattan Institute wrote in a Wall Street Journal op-ed: "ISS 

receives a substantia} amount of income from labor-union pension funds and 

lsociallyresponsible' investing funds, whlchgives the company an incentive to favor 

proposals that are backed by these clients."" As a result, the behaviors of proxy advisors ~jdeviate from concern over share value, [suggesting] that this process may be 

oriented toward influencing C'orporate behavior in a manner that generates private 

70. "bepa:rtmentof Justice Sues Standard & Poor's for Fraud in Rating Mortgage-Badred Securities in 

the Years I.eading Up to the Fina..."lcial Crisis,"United States Deparnnent of Justice (February 5, 2013), 

http://wwwJustiee.gov/opajpt/2013/February/l3~ag-lS6.btml. To be clear, the authors doubt that thi~ 

particular lawsuit has merit.. See "Payb~ck for a Downgrade? The Peds Sue S&P but not Moody's for Precrisis Cre~rr Ratings,'" Wall Street Journal, February 5, 2013, hnp:/ /online.wsj.com/artide/SBlO0014140 

S3111903596904576S1B460I62935404.htmL 

71. Charles M. Nathan and parol Mehta, 1'he paranel Univ.ers!'...'; ofIJ1stirutional Investing and 

Institutional Voting (Rochester. NY: Social Science Research Network, 2010), 3. 

72. See "Comment from Franklin Tempe:lton Fund on SEC Proposed Rule," SEC, December 9, 2002., 

http;/lwww.scc.gov/mles/proposed/s73602(m1simpsonl.htm. 

73. Opinion, "Politicized Proxy Advisers vs.l:ndividuaI Investors," Wall StreetJoumru. October 7, 20ll, 

http://online.wsj.com!article!SBlO0008723963904446201045780U2S2US63290B.htmL 

21 
273 


81762.236

M.ERCATUS CEHTE:R .'\T GEORGE rl,ASON UNtVERSIT ( 

returns to a subset of investors while harming the average diversified invest.or :174. 

The legacy of the SEC's proxy policy rules appears to have encouraged a focus, in the 

words of SEC Commissioner Daniel Gallagher, on "social and political issues rather 

than issues that would be material to investors."";; 

The second variety of conflict that tiUnts advisors is thatthey prnvide consulting 

services to the issuers about whom they make voting recommendations to mutual 

funds. These consulting services are designed precisely to facilitate managers' 

obtaining favorable recommendations. Copland writes about ISS: 

About 20% of its revenues also corne from consulting contracts 

with companies about corporate governance issues and executive comp~nsation, according to MSCI's 2011 annual report. 

Shareholder proposals that increase corporate sensitivity to ISS 

preferences would have the effect of increasing the incentive for 

public companies to enter into such consulting contracts with ISS . 

... From2006 to 2012, ISS supported 35% of shareholder proposals 

related to environmental issues such as global warming or naturalgas hydraulic fracturing, and 70% of proposals seeking to increase 

disclosure of or to limit corporate political spending. Only one such 

proposal has received the support of a majority of shareholders." 

The SEC's Egan-Jones Letter, issued by the SEC shordy after its proxy advisor 

rule was enacted, addressed this potential conflict: 

An investment adviser could breach. its fiduciary duty of care to 

its clients by voting its clients' proxies based upon the proxy voting firm's recommendations with respect to an Issuer because the 

proxy voting firm could recommend that the adviser vote the proxies in the firrn·s own interests, to further its relationship with the 

Issuer and its business of providing corporate governance advice, 

74. James R. Copland, YevgeniyF~yman. and Margaret O'Keefe., "Proxy Monitor 2012: A Report on 

Corporate Governance and Share..~older Activism" (F.al120U): 3, http://proxymonitor.orgfpdf/pmr 

_04.pd£ 

75. NingChiu, "SEC Commissioners take divergent views on corporate governance and related disclosure regulations," urology, February 26, 2013. http://www.lexology.com;1ibfID.Y/detail 

aspX?g='dlnd7fb-a090-4338-aff7-55d8bSfe13cL 

76. Opinion. "'Politicized Proxy Advise.rs vs. Individual Investors," WaU Street Journal. October 7, 2012, 

http://online.wsj.coro/artide/SBlO00087:l396390444620I.0457801225212S632908.hanl. 

22 
274 


81762.237

rather than in the interests of the adviser's clients. The proxyvotingfirm's relationship with an Issuer thus may present a conflict of 

interest that is in addition to any confliet of interest that the invest~ 

ment adviser may h,ave. n 

While the SEC staff clearly recognized the potential for conflict, the letter then 

took. turn th.twas surprisingly deferential to the proxy advisory firms by suggestingthat disclosure would be sufficient to relieve the problem: 

Accordingly, an investment adviser should obtain information 

from any prospective independent third party to enable the adviser 

to determine that the third party is in fact independent, and can 

make recommendations for voting proxies in an impartial manner 

and in the best interests of the adviser's clients .... For instance, 

underth"e circumstances thatyol,l describe in your letter, the procedures should require a proxyvotiugfirm that is called upon to make 

a recommendation to an investment adviser regardingthe voting of 

an Issuer's proxies to disclose to the adviser any relevant facts concerning the firm's relationship wi1h an Issuer, such as the amount 

of the compensation that the finnhas received or will receive from 

an Issuer.i'S 

Tills approach stands in stark contrast to other situati~ns in which the SEC has 

issued regulations motivated by conflict~of-interest concerns in the arena of corporate governance. In cases involving investment analysts1 for instance, the SEC 

has been quite aggressive. In its regulation of some non-audit advisory services 

offered by firms that conduct financial audits, the SEC was similarly dismissive of 

arguments that conflicts of interest could be managed merely through disclosure.'" 

(Debates over the advisability of the SEC's approach to potential conflicts ofinterest 

involving investment advisers or auditors are beyond the scope of this paper. The. 

examples suggest that the SEC's soft approach to proxy advisory firm conflicts of 

interest has been uncharacteristic.) 

The Department of Labor, which regulates pension plans nnder ERISA 

(Employee Retirement Income Security Act ofl974, the main law regulatiug pension plans), has taken a more forceful stand against conflicts of interest in voting 

proxies. DOL's Advisory Opinion 2007-07A expressed "strong concern about the 

77. SEC to Hughes, May 27. 2004. 

78.. Ibid. 

79. See, e.g., Strengthening the commission's Requirements Regarding Author Independence, 68 Ff'd. 

Reg. 6006 (February 5, 2003) (to be codified at 17 C.F.R pts. 210, 240, 249, and 274). 

23 
275 


81762.238

MERC:~.TUS CUJ rER AT Gt'OHGf.: !\l\.i\SON UNI',;r::H~;iT ( 

use of plan assets to promote particular legislative, regulatory or public policy positions that have no connection to the payment of benefits or plan administrative 

expenses."1'1.0 The letter used this example: 

The likelihood that the adoption of a proxy resolution or proposal 

requiring corporate directors and officers to disclose their personal political contributions would enhance the value of a plan's 

investment in the corporation appears sufficiently remote that the 

expenditure of plan assets to further such a resolution or proposal 

clearly raises compliance issues under [ERISA]." 

In March 2011, the DOL's inspector general issued a report warning that unions 

may be usingUplan assets to support or pursue proxy proposals for personal, social, 

legislative, regulatory, or public policy agendas."" The inspector general noted that 

the Employee Benefits Security Administration (ESBA), the division of DOL that 

enforces ERISA} often lacked adequate assurances that plan fiduciaries or third 

parties like proxy advisory firms base their votes or recommendations for votes on 

actual economic benefit" It appears that the Labor Departmenfs Inspector (',eneral 

shares our concern that corporate voting policies by some politically active funds 

may be conflicted. 

It is possible that conflicts of interest posed by proxy advisory firms accepting 

consulting fees from issuers may already be prohibited under ERISA-or expose 

plan fiduciaries or proxy advisors to liability under the law. DOL has contemplated 

designating proxy advisors as fiduciaries under ERISA, a question beyond the scope 

of our anatysis.M Even in the absence of such a rule, reliance on proxy advisors who 

provide consulting services may be prohibited. 

When an ERISA fiduciary (that is, an official Of firm with influence over pension 

plan investments) appoints others to fulfill its obligations-such as when it gives vot· 

ingpower to a proxy advisor-the ERISA fiduciary also has an obligation to monitor 

those appointees.a:! If relying on an expert that also receives fees from those whom 

the expert is assessing-fees that relate to the very matters in question-is deemed 

unreasonable, then ERISA fidnciaries may not meet their obligations for prudence. 

Also, under ERISA, when a fiduciary acts to the benefit of a third party, even if 

BO. See 29 C.F.& § 2509.94-2 (2008). 

81. rbid . 

.82. "'Proxy-voting May Not be Solely-for the £(.onomic BenefitofRetirementPlans,"" Department of 

Labor, Office ofInspector General-Office of Audit. Employee Benefits Security Administration., Report 

No. 09-U·OOH.2~121 (March 31, 20ll): 4-8, http!/fwww.ojg.doLgov/public/reports./oa/2011/09~1l-001 

-U·U1.pdf. 

BJ. Ibid. 

84. Definition of the Term "Fiduciary," SEC, 75 Fed. Reg. 65,263, (October 22,2010). 

85. See Shirk v. Fifth Third Banrorp, No. 05~CV-49, 2007 WL 1100429, at ~n (S.D. Oruo April 10, 2007). 

24 
276 


81762.239

r,,'ERC:A.TUS CENTER A,T GEORGE N\r'\50N UNIVEHStl { 

the fiduciary's own interest is not implicated, the fidudarymayviolate its duty.86In 

addition, the lack of company-specific recommendations by proxy advisors and t1:te 

limited empirical evidence supporting those recommendations call into question 

whether ERISA fiduciaries are fulfilling their obligations. 

While the SEC's fiduciary rules for investme!lt advisers are less developed than 

the Department of Labor~s, many of the same principles could also inform interpretive guidance from the SEC to regulate the role of conflicts of interest faced by proxy 

advisors in corporate governance. 

Some proxy advisors or ERISA fiduciaries might provide boilerplate disclosure 

about the possibility of conflicts stemming from con~ulting fees, yet in analogous 

contexts,1ike those involving auditors whose firms offer consulting services, institutional investor groups have been highly suspicious and have found disclosure or 

firewalls to be insufficient remedies. 

For instance, the California Public Employees' Retirement System (CalPERS) 

advocates the following dear principle on auditor independence: "The external 

auditor should not provide internal audit services to the company:~fl7 Consulting 

services provided by the same entity that provides the external assessment represent an unavoidable conflict of interest in the view of CalPERS, which, with $254 

billion in assets, serves 1.6 million members. It would seem that a similar problem 

is present when the same proxy advisory firm may be called upon to provide an 

external rating of a corporate governance proposal or mechanism it helped design. 

In addition, the Council of Institutional Investors advocates that u a company's· 

external auditor should not perform any non~audit services for the company~ except 

those, such as attest services, that are required by statute or regulation to be per~ 

formed by the company's external auditor."'!!!! Some proxy advisors have attempted 

to keep their work in proxy reco~endations separate from t1:teir consulting work 

for issuers.59 Still, it would seem inconsistent to argue that auditors providing tax 

structuring advice or internal audit consulting to the issuers they audit represent 

such an o~tr.usive conflict of interest that the practice must be banned outright1 

and at the same time argue that proxy advisors can successfully avoid the conflicts 

posed by providing consulting services to the "issuers about whom they make voting 

recommendations.90 

Indeed, the analogy to auditing fees aetuallyunderstatesthe eonflictinvolved. To 

be funy analogous, we would have to consider a situation where auditors provided 

issuerswith·consulting services about how to navigate successfully an outside audit 

(and by the same firm). 

86. See Bevel v. Higgonbomam, Civ,~98-474-X, 2001 WI. 1352896, at *14 (ltD. Okla. Oct 4, l001). 

87. See Global Principles of Accountable Corporate Governance, CalPERS, November 14, lOll at2? 

B8. See Global Principles of Accountable Corporate Governance, CalPERS, November 14,2011 

B9. See Concept Release on the UB. Pmxy System, SEC, 75 Fed. Reg. 42,981, 43,009 (July 22, 2010). 

90. See "Comment from Council ofrnstitutional Investor.: on SEC Pmposed RuleJ " SEc,. January 10, 

2003, http;llwww.sec.gov/rules/proposed/s74902/sabteslild.htm. 

25 
277 


81762.240

MERCATUS CHlTER AT GEORGE Mi~SON UN1VERS,!T", 

Court. have held that obligations imposed by ERlSA should be construed consistently with those of the federal securities laws." Thus, to the extent that these 

principles cross over to the fiduciary obligations owed by proxy advisors and the 

investment advisers who rely on them, similar restrictions and liability risks from 

proxy advisor consulting fees may be present. 

We have now examined three sources oflow~quality advice: lack of resources, 

"misaligned incentives. and conflicts of interest. Conflicts may already violate DOL 

regulations, which in turn provide guidelines for the SEC to follow. We have other 

recommendations as well to fix the current broken system. 

VII. RECOMMENDATIONS 

THE PROXY ADVISORY industry was principally created byregulation. Without regulatory mandates requiring active participation in proxy votes, and without interpretative releases givingprefe"rential treatment to investment managers who use proxy 

advisors, a profitable proxy advisory industry might not exist. 

There ate legitimate COncerns about merely adding more regulations~ such as 

requirements that proxy advisors further "professionalize" their staffs or that a 

mandatory disclosure regime be created to solve a problem caused by regulation. 

The result of additional rules, as with credit-rating agencies, is often to make the 

regulated institutions less open to competition and closer to their regulators, a phe:--

nomenon known as Uregulatory capture." Also, as we have seen, regulations often 

produce unintended consequences, It was no surprise that the US Chamber of 

Commerce, in a set of proposals in March for repairing th~ proxy advisory system, 

rejected the regulatory approach .. ' 

On the other hand, replacing poor regulations with well-designed regulations 

can render businesses more exposed to the normal market forces that produce good 

outcomes. 

The Egan-Jones letter shifted fiduciary responsibility for proxy decisions from 

mutual funds to third parties while simultaneously limiting the fiduciary exposure 

of those third parties. In the end, except in extraordinary .cases, no one is responsible 

for representing the interests of shareholders. As a remedy, the law firm Wachtell, 

Lipton, Rosen & Katz argued, according to a piece in the New York Times, ~·that 

proxy advisory services should be subject to the proxy solicitation rules. If these 

rules applied, shareholders aod public companies could sue the advisory services 

over disclosure lapses in their recommendation reports,"93 It is possible, of course, 

91, Shirk, 2007\VL 1100429, at~. 

92. Ros.~ Kerber, "Chamber of Commercewmts more proxyadvisot disclosures," Reuters, March 

20,2013, http://www.reuteTs.com/aTtid~/2013/03120jus~proxy-advisors-chamber-idUSBRE_ 

92JOSU0130320. 

93. Steven M.. Davidoff, "Proxy Firms Need More Rules., Companies Say,'" DealBook. NovembEr 30, 

2010, http://dea1book.nytimes.c.om/2010jll(3ojin-one-area-companies-want-more-regulationj. 

26 
278 


81762.241

i\I\ERCATUS lflH£.R i\l CEOR.GE ,\tASON UN1VtRSlTY 

that "by imposing this liability, the ability of proxy advisors to make recommendations would be chilled, if not killed."'" This paper does not suggest either amandatory disclosure regime or the Lipton proposal, though both are valid options that 

deserve a place in the debate. 

At a bare minimum, regulators must act to end to proxy advisor services' conflicts of interest, actual and potentiaL The firms must choose their clients: either 

corporate share issuers or investment institutions such as mutual funds-but not 

both. Even if this conflict were eliminated, the change would not remove that 

possibility that ISS would favor the ideological and political views oflarge proxyadvisory clients. That bias can~t be removed through oversight, only through competition. In other words, ifitwere more broadly known that ISS recommendations 

diminished shareholder value, both kinds ofpotentialdients might look elsewhere 

for advisory services. 

Knowledge 'about shareholder value depends on research, and this sort of 

research is difficult to design because the advisory firms lack transparency. If 

regulators eliminate rules that offer preferential treatment to proxy advisors and 

the firms that use them, and eliminate the regulatory mandate for active voting 

policies, disclosure will occur voluntarily through market forces. This voluntary 

disclosure can occur along the lines recently suggested by the US Chamber, asking 

that proxy advisors 

review the effects of their recommendations six months, or as prac~ 

ticable, after relevant proxy votes, and publish those results (with 

other necessary data) to permit interested persons to assess the 

accuracy, validity, and appropriateness of the PA Firm1s recommendations .... These reviews should pennit regularly revisiting 

and, if appropriate, modifying, proxyvoting policies to ensure that 

they have a positive-or at aminimumno negative-effect on shareholder value." 

Unfortunately, ISS issued a response to the Chamber's suggestion that illustrates 

the extensive buffer it enjoys from market competition: 

94. Ibid. 

We take exception with the Chamber's misinformed characteriza.-

tion of the proxy advisory industry and with their disrespect for 

the financial institutions that are our clients and, ironically, some 

of the Chamber's own members . ... We are accountable to our 

95, "Best Practices and Core Principles fur the Development, Dis:pe:nsation~ md Receipt of Proxy 

Advice," Center fur Capitsl Markets Gompetitivenes~ Chamber of Cnmmerce (Mar<:b 2013); 7, http:// 

www.c-enteriore.a.pitrumarkers.cora!wp-content!uploads/2010j04/Best-Pra;;:tice.s-and~Core-Princlplcs 

-for-Proxy-Advi.,>ors.pdf. 

27 
279 


81762.242

MERG\TU5 CEI'-J fEF; /',T GEORGE fv\.ASON UNIVH:SlTY 

clients who place their confidence in our scrvice, to the companies 

we analyze and to the regulators that set the real guidelines for 

fiduciary responsibility. The Chamber should take its own advice 

by grounding its '''Prindples'~ in actual facts rather than its own 

self~serving interests.9~ 

Fixingthe current system also requires that we acknowledge that mutual funds 

can.1t possibly make considered judgments about tcns of thousands of proxies, and 

thatitis not in their best interest to do so. (tInstitutio~al investors like mutual funds 

and pension funds do not have the resources to analyze and consider aU these proposals," as Steven Davidoff, a law school professor, wrote in the New York Times.9'J 

TIAA-CREF, for instance, holds stock in 7,000 companies and must cast more than 

100~OOO votes a year. Instead of requiring mutual funds to engage in active analysis of tens of thousands of votes, the SEC could allow funds and their advisers to 

determine when such analy~is would be in their fund's best interest. This approach 

recognizes that the ultimate source of the problem is not the way ISS conducts its 

business butthe burden the SEC has imposed on mutual funds that made them turn 

to ISS in the first place. 

That burden is compounded by Dodd-Frank's insistence that shareholders cast 

certain votes, such as Say-on-Pay. We believe such proxy-requirements are unnecessary. If issuers ignore the wishes of shareholders, then shareholders will take 

appropriate action through self-funded proxy fights, filing civil lawsuits, taking 

short positions, or simply voting with their feet by selling shares, thereby sending 

the powerful signal of a falling stock price. 

In the absence of such a policy shift, many institutional investors cannot or will 

not dedicate sufficient resources to develop indivIdual assessments of all proxies. 

And, since the SEC has provided them with what appears to be a legal "safe haven," 

these mutual funds will continue to turn to firms like ISS, firms that cannot adequately evaluate all the companies in the investment universe. 

On the other hand, if the SEC recognized the limitations of the current policy, 

investors would benefit from lower costs and a decrease in the risk associated with 

centralized decision making. This change would not necessarily eliminate the role 

of proxy advisors but would reduce itto its proper weight in the scheme of corporate governance. Holly Gregory of the law firm Weill, Gotshal & Manges recently 

wrote on the blog of the Harvard Law School Forum on Corporate Governance 

96. "ISS ReSponse to the u.s. Chamber of Commer('e's Guidelines for Proxy Advisory Firms,'> ISS, 

accessed April 4, 2013. http://www.issgoverrumce.com/pressjissreponsechambcrofcommerce. 

97. Davidoff, "ProqFinns Need More.Rules, Companies Say." 

28 
280 


81762.243

iv",ERCATUS CEdTER. .Aj" GEORGE M.!>..~ON UNJ\!CRSJT i 

and Financial Regulation, ((Decisions to utilize the services that proxy advisors 

offer should be made on an informed basis after appropriate due diligence, especially if the shareholder is an institutional investor that owes fiduciary duties to 

benefidaries.0I98 

Those fiduciary duties include serious considerations of costs versus benefits. A 

perverse result of mandating that institutions vote ail matters on a company proxy is 

that the SEC is essentially saying all issues are important to all shareholders. In fact, 

the potential benefits realized by voting on certain items, as required by SEC regulations, are outweighed by the cost to the fund of conducting a proper evaIuation-a 

cost ultimately absorbed by the shareholders. In other words, the cost of, say, deciding how to vote proxies on 1,000 shares of a stock owned by a mutual fund with high 

turnover subtracts from shareholder value. 

A report by the law firm Latham & Watkins, LLP, cites a 2008 interpretation by 

the Department of Labor, which found 

that an investment adviser's fiduciary duty requires it first affirmatively to conclude that the potential economic benefits to share 

value arisingirom the act of voting outweighs [sic] the costs of voting (including the risk that the vote could decrease share value), 

with voting being appropriate only for those matters at a particular 

company that are determined to have greater bene-fit than cost. 99 

So far, neither the Department of Labor nor the SEC has reconciled this need for 

benefit-cost analysis with universal active proxy voting policy requirements. While 

the 2008 DOL interpretation tried to address the universal active voting mandate, a 

shift in priorities and a lack of enforcement at the DOL has since undercut the 2008 

interpretive tetter. 

The SEC also has yet to address the responses to its 2010 concept release on 

proxy voting. When it does, it must recognize that its own interpretation of the orig~ 

ina12003 rule is at the root of the trouble-and the trouble is that two small firmB, 

and one in particular~ have become the central arbiters of corporate governance in 

America, and those firms are not equipped or incentivized to make value-enhancing 

decisions. 

98. Holly Gregory, ''Preserving Balance in Corporate Governance;" The Harvl1rdLaw School Forum on 

Corporale Governance and Financial Regulation (blog), February 1, 2013, http:!,lblogs.law.hatVardedu 

!corpgav!2013!02/01!preservlng-balftIlce-in-corporate-gov.ernancej. 

99. "Proxy Advisory Business:. Apotheosis or Apogee?," Corporate Governance Commentary, Latham & 

watkinsLLP (March 2011): 2, citing 29 CF.R § 2509 (2008). 

29 
281 


81762.244

j\-\ERCATUS Cl:hJ (ER A1' Gi::ORGE MASON UNIVER.'.;.!T l' 

Three steps are needed to fix the problemo 

1* Limit proxy voting requirements of inutual funds and pension funds so that 

those institutions will be the sole arbiters of when it makes sense to vote using 

active analysis of the question at hand. The test should be whether the vote 

enhances the value of an investment to a significant degree and whether the 

benefits of the voting process exceed the costs. 

2. End the preferential regulatory treatment that proxy advisors curreritlyenjoy 

in the law. That process must start by rescinding the Egan-Jones letter issued 

by the SEC staff. Institutional investors would remain free to purchase proxy 

advisory services if those services are valued for their own merit. Continued 

resistance by proxy advisors to sharing the empirical foundation for theirrecommendatiollS suggests demand for their services may decline in the absence 

of their regulatory advantages. 

3. End extraneous proxy requirements, such as Say-on-Payvotes. Letshareholders and directors decide the matters that should be put to votes, if any, beyond 

those already required under state corporate law. 

All three steps are reasonable, nonideological, and address a pressing problem. 

They should be relatively easy to accomplish. However, if step 2 is not enacted, 

we would advocate as an alternative limiting proxy advisors to a single business 

in order to mitigate conflicts of interest. They can advise issuers on corporate 

governance and getting proxy proposals passed, or they can advise mutual funds 

and other financial institutions on how to vote-but not both. As we noted in the 

previous section, such a conflict may already subjectERlSA plans relying on proxy 

advisors to potential liability. The SEC's rules for mutual funds and their advisers 

recognize this conflict. 

The time for ref.orm is now. The regulatory advantages proxy advisory firms 

enj oy should be curtailed in the interest of America's shareholders. 

30 
282 


81762.245

Outsourcing Shareholder Voting to Proxy Advisory Firms 

David F. Larcker' 

larcker david@gsb.stanford.edu 

Graduate School of Business 

Rock Center for Corporate Governance 

Stanford University 

Allan L. McCall 

amccall@stanford.edu 

Graduate School of Business 

Stanford University 

Gaizka Ormazabal 

gormazabal@iese.edu 

lESE Business School 

University of Navarra 

Draft: May 10,2013 

'Corresponding author 655 Knight Way, Stanford, CA 94305-7298. We thank Yonca Ertimur, 

Fabrizio Ferri, Joseph Grundfest, Katherine Rabin and seminar participants ofthe 2012 London 

Business School Accounting Symposium for helpful comments. Ormazabal acknowledges 

funding from the Ramon y Cajal and Marie Curie Fellowships. Michelle Gutman and Brian 

Tayan provided excellent research help for this project. We would also like to thank Institutional 

Shareholder Services for providing some of the data used in this project and the Stanford Rock 

Center for Corporate Governance and the Stanford Graduate School of Business Center for 

Leadership Development and Research for their support. 
283 


81762.246

Outsourcing Shareholder Voting to Proxy Advisory Firms 

Abstract: This paper examines the economic consequences of institutional investors 

outsourcing research and voting decisions on matters submitted to a vote of public company 

shareholders to proxy advisory firms. These outsourcing decisions appear to be the result of the 

regulatory requirement that institutional investors vote their shares combined with incentives for 

these investors to minimize their cost of voting activity. We investigate the implications ofthese 

decisions in the context of shareholder say-on-pay voting required in 20 II under the Dodd-Frank 

Act. Analyzing a large sample of firms from the Russell 3000 that are subject to the initial sayon-pay vote mandated by the Dodd-Frank Act, we find three primary results. First, consistent 

with prior research, proxy advisory firm recommendations have a substantive impact on say-onpay voting outcomes. Second, a significant number of firms change their compensation 

programs in the time period before the formal shareholder vote in a manner consistent with the 

features known to be favored by proxy advisory firms in an effort to avoid a negative voting 

recommendation. Third, the stock market reaction to these compensation program changes is 

statistically negative. These results suggest that the outsourcing of voting to proxy advisory 

firms appears to have the unintended economic consequence that boards of directors are induced 

to make choices that decrease shareholder value. While this evidence does not speak to the 

optimality of outsourcing all voting decisions compared to alternative regulatory constructs (e.g. 

prohibiting proxy advisors or reducing the number of items to be voted on), it does inform this 

debate by providing evidence on the potential negative economic consequences of outsourcing 

shareholder voting to proxy advisors. 

Keywords: proxy advisory firms; say-on-pay; institutional shareholder voting 

JEI Classification: Gl; G3; K2; L5 
284 


81762.247

1. Introduction 

Significant regulatory, financial press and academic research attention has been paid in 

recent years to mechanisms that will give shareholders of public companies more control over 

firms' corporate governance. While most of the focus has been on actual or perceived failings of 

corporate governance within firms, relatively little attention has been paid to how large 

institutional shareholders actually utilize their increased influence to affect the governance 

choices of individual firms. I This is an especially important issue because the number of 

opportunities for shareholders to cast votes on various corporate governance items has increased 

in recent years (e.g. through shareholder proposals and mandated votes such as say-on-pay) and 

firms are increasingly responsive to voting results.2 

Like many instances of voting by a dispersed base, shareholder voting is subject to free rider 

problems because any individual shareholder's vote likely matters very little, but they bear the full 

cost of researching matters subject to vote. While retail investors can choose to not vote, institutional 

investors have a fiduciary obligation to cast votes on virtually all shareholder ballots, and therefore 

they represent the preponderance of votes cast. If the free rider problems sufficiently dilute the 

benefits of engaging in costly research to identiJY the optimal voting choice, institutional investors 

may choose to engage in a low cost voting strategy that meets their regulatory requirements but 

might not result in optimal feedback to the firms. In this paper, we examine the characteristics and 

the economic consequences of institutional investor voting, and in particular the outsourcing of 

voting to cost-effective third parties such as proxy advisory firms. 3 

lOur focus is on governance choices influenced through the regular corporate vote channels. This is different from 

research on shareholder activism (e.g. Gillan and Starks, 2007, and Barber, 2007) which has been largely 

inccnclusive on the value implications to shareholders. 

2 Among firms covered by ISS Voting Analytics the average number of ballot items per firm increased from 6.48 in 

2003 to 9.46 in 2011. 

3 A recent (somewhat extreme) example of outsourcing is the decision ofBlackRock to outsource voting on the 

question of whether to split the chairman and CEO for JPMorgan Chase to Governance for Owners. Since 
285 


81762.248

Institutional investors generally have a fiduciary responsibility to vote shares in their 

portfolios in a manner that is beneficial to their shareholders.4 In 2003, the SEC further increased the 

requirements for mutual funds by requiring them to disclose their voting policies as well as disclose 

how they actually voted on every ballot item. A key objective of this regulation was to motivate 

institutional investors to monitor firms in a manner that benefits all shareholders (SEC, 2003). 

However, institutional investors tend to have relatively small holdings in a large number of stocks 

making the cost of researching every ballot item at each annual meeting for all stocks in their 

portfolio costly.5 Moreover, the economic benefits to an institutional investor conducting this 

research (presumably by forcing appropriate governance changes and reducing agency problems) are 

likely to be quite small because an individual fund only recognizes the partial benefit associated with 

its small ownership stake in firms where the investor is the pivotal voter, while incurring all the costs 

ofthis research activity (i.e., traditional free-rider problems confront each institutional investor). 

One consequence of this is that shareholder voting processes have taken on characteristics of 

compliance function (i.e., making sure that the votes are cast according to a specific policy), as 

opposed to an activity involving the portfolio managers who are engaged in research reSUlting in buy 

or sell decisions for shareholders in the funds. 6 

BlackRock owned approximately 6.5% of the shares of lPMorgan Chase, they were required to outsource to an 

independent third party under the Bank Holding Company Act (see Craig and Silver-Greenberg, 2013). 

4 Throughout the paper, we use the term "institutional investors" to include all non-individual investors such as 

mutual funds~ pension funds~ endowments, insurance companies, and other similar entities. These investors usual1y 

have a fiduciary responsibility to vote their shares, but the relevant controlling regulations vary across investor 

types. Mutual funds are a subset of the larger group that are specifically subject to the changes in voting 

requirements and disclosure ofactual votes implemented in by the SEC in 2003 

5 Glass Lewis & Co. notes, "Most institutions do not have adequate in-house resources to ensure that the right 

decisions are being made on the hundreds or thousands of proxies they vote each year". Source: 

www.glasslewis.comlsolutionslproxypaper.php (accessed April 22, 2011) 

6 For instance, at Fidelity Investments, according to their proxy voting policy, proxy voting is conducted by a 

separate internal group and does not explicitly provide for input or recommendations from portfolio managers or 

research analysts covering the firm on many common proxy items. Fidelity's policy provides for consulting 

portfolio managers on items for which no guidelines have been established. However guidelines have been 

established for many common circumstances, including director elections, equity compensation plans, stock option 

exchanges and "say-on-pay" advisory votes, implying that portfolio managers would not ordinarily participate in the 

2 
286 


81762.249

In this market setting, we would expect "corporate governance research entities" such as 

proxy advisory firms to form and invest in costly data collection and research where this cost is 

ultimately shared across many institutional investor clients. 7 That is, institutional investors will tend 

to outsource their voting decisions to these proxy advisory firms as long as their net benefits will 

exceed those from doing all the necessary research in-house. 8 This is even a more likely outcome 

after the SEC (2003) issued an interpretation that the use of proxy voting policies developed by an 

independent third party (i.e., proxy advisors) would be deemed free of a conflict of interest and 

would meet mutual funds' proxy voting obligations. Thus, the least costly way to satisfY an 

investors' regulatory responsibility to cast shareholder votes can easily be to outsource voting to 

Institutional Shareholder Services (ISS) or Glass Lewis (GL). 

The important public policy issue in this setting is whether the payments made by 

institutional investors are sufficient for the proxy advisory firms to engage in costly research to 

develop "correct" governance recommendations from the perspective of firm shareholders. If the 

institutional investors are only using the proxy advisor voting recommendations to meet their 

compliance requirement with the lowest cost, these payments will not compensate proxy advisors for 

conducting research that is necessary to determine appropriate corporate governance structures for 

individual firms. Under this scenario, the resulting recommendations will tend to be based on 

simple, low cost approaches that ignore the complex contextual aspects that are almost certainly 

instrumental in selecting the corporate governance structure for individual firms. Given the 

review of those items (Fidelity Funds' Proxy Voting Guidelines, November 2010). Other firms completely 

outsource the voting process to third-party proxy advisors, bypassing input from portfolio managers. 

7 Since institutional investors hold shares in many thousands of individual domestic and international companies, a 

proxy advisory firm must have sufficient scale to provide voting recommendations for many proposals for this large 

number of firms. Thus, there are substantial fixed costs to start a competitor firm and the prospects of success are 

likely to be low given the "first mover" advantages of the two largest firms (ISS and Glass Lewis). Over the past 

decade, new entrants have failed to generate any meaningful market share (e.g., Egan Jones). The proxy advisory 

industry has the classic oligopoly structure. 

S An additional alternative available to institutional investors would be to make no investment in rese.arch of proxy 

items and simply make an arbitrary voting decision, such as always following management's recommendation. This 

strategy would carry significant legal/regulatory risk because, if discovered, the institution may have violated its 

fiduciary duty to its shareholders. 

3 
287 


81762.250

theoretical and practical difficulty of selecting corporate governance, there is no reason to assume 

that a simple approach to voting recommendations is optimal for the affected firms. However, if 

proxy advisors can influence enough shareholder votes, boards of directors will be forced or induced 

to respond by changing executive compensation programs and governance structure in a manner 

consistent with the recommendations of proxy advisor firms. The obvious question that remains to 

be answered is whether or not the confluence of government regulations, the outsourcing of 

recommendations the proxy advisory industry, and responses by boards of directors to these 

recommendations, produces an increase in shareholder value as anticipated by government regulators 

(SEC, 2003). 

In this paper, we examine impact of institutional shareholder voting, particularly the 

outsourcing of research and recommendations to proxy advisory firms, in the setting of shareholder 

say-on-pay voting. The Dodd-Frank Wall Street Reform and Consumer Protection Act (DoddFrank Act) imposed a requirement that public companies allow shareholders the opportunity to 

cast an advisory vote on executive compensation (typically annually) beginning in 2011. This 

requirement is commonly referred to as say-on-pay (SOP).9 Shareholders that disagree with a 

firm's executive compensation program can cast a non-binding (or precatory) vote "against" the 

management compensation program disclosed in the proxy statement for the annual shareholder 

meeting. The primary regulatory assumption with SOP is that firms will make changes to their 

compensation program when a substantial proportion of negative (against) votes are cast by 

shareholders. 

The implementation of SOP voting provides several advantages to other shareholder vote 

issues for purposes of evaluating the economic impact of vote outsourcing to proxy advisors. 

9 Prior to the Dodd-Frank Act, finns receiving aid under the Troubled Asset Relief Program (TARP) were required 

to conduct SOP votes beginning in 2009, and a small number ofnon-TARP finns voluntarily adopted SOP votes 

prior to Dodd-Frank. 

4 
288 


81762.251

First, the regulation is broad, effecting most of the U.S. equity market. Second, because this is a 

new proxy ballot item, inferences are less confounded by questions of timing (e.g., whether 

actions might be in response to a past vote or in anticipation ofa future vote). Finally, we exploit 

the fact that while SOP voting was new for most public companies, the policies used by proxy 

advisors to develop their recommendations were well publicized and known to boards of directors in 

advance the first SOP votes required by Dodd-Frank Act. This enables us to examine changes that 

boards of directors make to compensation programs in anticipation of the initial SOP votes and 

the shareholder reaction to those changes. If a board anticipates opposition to its executive 

compensation program and believes that this opposition is costly to shareholders (e.g., because it 

invites derivative lawsuits, negative press, regulatory scrutiny, or distracts executives and 

employees) or is personally costly to them (e.g., through litigation or reputation risk), it might 

rationally take preemptive actions to decrease the probability of receiving negative votes. In 

such a setting, the board of directors will be interested in anticipating whether institutional 

investors (who generally hold the majority of outstanding shares) will vote for or against a SOP 

proposal. 

We document that many institutional investors rely on proxy advisory firms, primarily 

ISS and GL, for data and analysis to guide their voting choices. Although each institutional 

investor ultimately controls the votes cast for its own shares, it is common for funds to rely in 

whole or in part on the policies and guidelines of proxy advisory firms to inform their SOP 

voting decisions (Belinfanti, 2010). For example, SEI Investment Management, Grantham, 

Mayo, and Van Otterloo, Evergreen Investment Management, Dimensional Fund Advisors, 

Wells Fargo Funds Management, and Nuveen Asset Management voted more than 99% of the 

time with the ISS recommendation. Similarly Charles Schwab, Neuberger Berman, Loomis 

5 
289 


81762.252

Sayles, and Invesco disclose that they follow GL SOP recommendations. 10 As a result, 

depending on their shareholder base, it is possible for firms to substantially decrease votes 

against SOP by obtaining a positive recommendation from proxy advisory firms. 

This shift in expected voting outcomes can be accomplished by making changes to the 

compensation program so that its features more closely align with the voting policies of the 

proxy advisory firms before the proxy statement is released and these firms issue their SOP 

voting recommendation. For example, in a recent survey conducted by The Conference Board, 

NASDAQ, and the Stanford Rock Center for Corporate Governance (2012), over 70% of the 

director and executive officer respondents indicated that their compensation programs were 

influenced by the policies of and/or guidance received from proxy advisory firms during their 

evaluation of SOP. If the policies and guidelines of proxy advisors effectively identify poor pay 

practices, changes made by boards of directors to align their executive compensation programs 

more closely with these policies will decrease executive rent extraction and increase shareholder 

value. However, if proxy advisor voting policies do not identify suboptimal corporate 

governance, changes made to align executive compensation programs with these policies could 

move compensation contracts away from the optimal structure and reduce the value of the firm. 

We provide insight into these potential shareholder value implications by examining the 

determinants of the SOP voting outcomes (including proxy advisor recommendations), assessing 

whether boards of directors make compensation plan changes that are favored by proxy advisors 

in anticipation of the first SOP vote, and estimating the economic consequences of these 

decisions for shareholders. 

10 While GL does not publish their recommendations to non-subscribers, we confirm that these institutions make the 

same vote in more than 99% of cases, which is consistent with use of the same recommendations. 

6 
290 


81762.253

Our tests are based on 2,008 firms from the Russell 3000 index that held their shareholder 

meeting in 2011 and were required to have a SOP vote under the Dodd-Frank Act. Consistent 

with prior research (e.g., Bethel and Gillan, 2002, Cai, Gamer, and Walking, 2009, and others), 

we first show that the proxy advisory firm recommendations substantially influence the voting 

tally. For example, a simple univariate analysis reveals that firms that received a negative 

recommendation by ISS (GL) obtained an average 68.68% (76.18%) voting support in SOP 

proposals. I I In contrast, firms that did not receive a negative recommendation from ISS (GL) 

obtained an average of93.4% (93.7%) support in those proposals. This differential voting effect 

is even more pronounced when the specific institutions owning shares in the firm historically 

rely more heavily on ISS recommendations (i.e., institutions are more likely to vote in line with 

ISS recommendations when there is a disagreement between the voting recommendation of ISS 

and management). Specifically, for negative SOP recommendations, we find that firms with 

investors that have an above-median likelihood of voting with ISS exhibit 63.5% support for the 

proposal, whereas firms where that likelihood is below median exhibit 73.5% support for the 

proposal. 

As a result oftheir ability to influence SOP votes, proxy advisory firms can induce firms 

to adopt compensation plan features that they are known to favor (e.g., performance-based equity 

and elimination of tax gross-ups in change of control plans). 12 While firms rarely discuss the 

specific role of proxy advisors in making changes to executive compensation in their public 

11 In the first year of SOP, finn, in our sample received, on average, 90.27% approval from shareholders. However, 

13.24% of companies received at least 20% votes against their plan and 32 of the sample companies actually failed 

their vote (less than 50% of vote cast in favor of management's proposal). 

12 For example, General Electric stated that changes were made to stock options previously granted to the CEO after 

"a number of constructive conversations with shareowners" (General Electric SEC Fonn DEFAI4A filed April 18, 

2011). Disney initially tried to argue that shareholders should igoore a negative vote recommendation from ISS 

(The Walt Disney Company SEC Fonn DEFAI4A filed March 2, 2011), but later removed the key feature causing 

the negative ISS recommendation without discussion of the reason (The Walt Disney Company SEC Fonn 

DEFAI4A filed March 18,2011). ISS changed their SOP recommendation for Disney on the same date (ISS Proxy 

Voting Report dated March 18,2011). 

7 
291 


81762.254

filings, reports by business media indicate that these changes were made in response to proxy 

advisor policies. I3 

Our primary tests examine compensation changes made in the time period preceding the 

SOP vote that better align the compensation program with known proxy advisor policies. We 

find that these changes are more likely to be observed among firms that expect to receive a 

negative SOP recommendation in the absence of a compensation plan change and where ISS can 

influence a substantial number of shareholder votes. Since most executive compensation 

changes must be publicly disclosed on Securities and Exchange Commission (SEC) Form 8-K, it 

is possible to precisely estimate the stock market assessment of these decisions by the board of 

directors. We find that the average risk-adjusted return on the 8-K filing date is a statistically 

significant -0.44% lower among compensation changes aligned with proxy advisor policies than 

among compensation changes unrelated to proxy advisor policies. Moreover, this effect is 

unique to 8-K changes in the time period before SOP and similar results are not observed for 

earlier time periods. 

As with all observational studies, there are a variety of alternative interpretations of this 

result. However, we believe that the most plausible conclusion is that the confluence of the 

regulatory environment and free ridership problems inherent in shareholder voting leads 

institutional investors to outsource the proxy voting decision to proxy advisory firms, but that 

they are not willing to pay for research sufficient to induce optimal governance choices in firms. 

lJ For example, see Joann S. Lublin, "Firms Feel 'Say on Pay' Effect," The Wall Street Journal, May 2,2011; and 

Andrew Dowell, and Joann S. Lublin, "Strings Atrached to Options Grant for GE's Immelt," The Wall Street 

Journal, April 20, 2011. Twelve firms made changes to (or commitments to change) compensation programs after 

filing their proxy statement containing the SOP proposal, and subsequently received a positive recommendation 

from ISS. Ten of these firms received a positive ISS recommendation on the same date as the public announcement 

of their revised compensation programs, one received positive recommendation two days later, and the last firm 

received a positive recommendation three weeks later. Nine of the 12 firms had received an initial negative 

recommendation from ISS that was reversed to a positive recommendation when the firm disclosed its changes. The 

other three firms received their initial (positive) recommendation from ISS immediately after filing amendments to 

their proxy statements. 

8 
292 


81762.255

As a result, the proprietary SOP policies of proxy advisory firms induce the boards of directors 

to make compensation decisions that decrease shareholder value. While we cannot assess the 

overall social welfare effect related to the outsourcing of proxy voting to the proxy advisory 

industry, this paper informs this debate by providing evidence on the potential negative 

economic consequences of outsourcing shareholder voting to proxy advisors. 

The remainder of the paper consists of six Sections. Section 2 discusses the institutional 

background for proxy advisory firms, SOP and prior research on these topics. Section 3 

describes our sample selection. Section 4 presents our analysis of the determinants of proxy 

advisors' SOP recommendations. Section 5 assesses the influence of proxy advisors on 

shareholder voting. Section 6 examines the responses by boards of directors to proxy advisors' 

policies, the economic consequences of these responses, and an assessment of alternative 

interpretations of our results. Summary and concluding remarks are provided in Section 7. 

2. Institutional Background and Literature Review 

2.1 Proxy Voting Requirements for Institutional Investors 

Institutional investors are generally fiduciaries for the ultimate economic owners of the 

assets they are investing, which obligates them to a duty of care and loyalty that includes 

exercising the voting rights on shares in their portfolios. Prior to 2003, there was little insight 

into how individual institutional investors were actually using their voting power. In response to 

concerns that institutional investors were conflicted in their voting by other business dealings 

with issuers, as well as significant pressure from organized labor groups, the SEC adopted new 

voting requirements in 2003 (Cremers and Romano, 2009). The key requirements of the 2003 

regulations were for mutual funds to disclose their votes on all shareholder ballot items, as well 

9 
293 


81762.256

as the policies and procedures used to determine their vote (SEC, 2003). The SEC summarized 

the objectives of requirements in the final rule: 

Proxy voting decisions by funds can play an important role in maximizing the 

value ofthe funds' investments, thereby having an enormous impact on the 

financial livelihood of millions of Americans. Further, shedding light on mutual 

fund proxy voting could illuminate potential conflicts of interest and discourage 

voting that is inconsistent with fund shareholders' best interests. Finally, requiring 

greater transparency of proxy voting by funds may encourage fonds to become 

more engaged in corporate governance of issuers held in their portfolios, which 

may benefit all investors and notjustfond shareholders (SEC, 2003, emphasis 

added). 

The objectives stated by the SEC clearly assume that institutional investors will conduct 

the research necessary to cast votes that will lead to "optimal" corporate governance choices. 

However, each institutional investor also faces a classic free rider problem. Most institutional 

investor holdings are relatively small portions of each firm's total securities [in our sample, the 

mean (median) holding is 0.3% (0.03%)]. This makes it unlikely that a given institution is a 

pivotal voter on any ballot item. Most of these institutions also hold a large number of securities, 

making the cost of engaging in research necessary to determine the correct vote on every proxy 

item very high. These free rider problems make it clear that there are economic incentives for 

institutional investors to not invest in costly research on proxy votes. 

Determining how to vote on complex issues of corporate governance typically involves 

evaluating a wide range of idiosyncratic firm issues, such as each director's experience and their 

cumulative skills, appropriateness of firm oversight and strategy, firm compensation relative to 

fum strategy, personal characteristics of executives, practices of other industry and labor market 

competitors, and many others features of the economic setting. This type of research is not the 

primary business of most institutional investors. As a result, outsourcing this research (and in 

many cases the voting decision) may be the most cost efficient means of meeting their obligation 

10 
294 


81762.257

to vote their owned shares. 14 At the same time the new proxy voting rules were finalized, an 

interpretative letter from the SEC provided that the use of proxy voting policies and 

recommendations developed by an independent third party such as proxy advisors would be 

deemed free of a conflict of interest and would meet mutual fund proxy voting obligations. 

From a compliance perspective, this ruling provided considerable incentives for mutual funds to 

rely on the recommendations ofthird-party proxy advisory firms, particularly when they might 

be perceived to have conflicts of interest arising from other business dealings (Belinfanti, 20 I 0). 

If the free rider problems are substantial and portfolio managers do not use the proxy advisory 

firm recommendations in stock selection, institutional investors will not pay higher fees for 

better research beyond that necessary to meet the simple compliance requirements. If the 

resulting ISS and GL SOP recommendations are inappropriate, corporate governance changes 

induced by these votes are unlikely to increase shareholder value. These concerns have not gone 

unnoticed by the SEC, as (former) Commission Chairwoman Mary Shapiro noted, the SEC will: 

" ... be examining the role of proxy advisory firms. Both companies and investors 

have raised concerns that proxy advisory firms may be subject to undisclosed 

conflicts of interest. In addition, they may fail to conduct adequate research, or 

may base recommendations on erroneous or incomplete facts" (emphasis 

added). IS 

2.2 Proxy Advisory Firms 

Past research has documented that proxy advisor recommendations have a significant 

impact on the voting outcomes on various types of shareholder ballot items. For example, 

Morgan, Poulsen, and Wolf (2006) investigate trends in shareholder voting on management 

14 For instance, passive index funds typically do not conduct finn-specific corporate governance research for their 

trading activities. Although actively managed funds may trade on selected governance characteristics, this does not 

appear to be a key part of their typical fundamental investment strategies based on our interviews with portfolio 

managers at six large mutual funds. Moreover, the recent Tapestry Networks and IRRC Institute (2012) study of 

how mutual funds vote finds that many funds outsourced their voting on say-on pay to proxy advisory firms. 

)5 Speech by Mary Schapiro, from NACD Directorship Magazine, Dec. 2010/Jan. 2011, p. 48 

11 
295 


81762.258

sponsored compensation programs. Over the time period from 1992 to 2003, affirmative voting 

for these management sponsored proposals declined, and in particular, negative vote 

recommendations of a proxy advisory firm resulted in a 20% increase in negative votes cast. 

Similarly, Bethel and Gillan (2002) and Cai, Gamer, and Walking (2009) find that a negative ISS 

recommendation on a management proposal can sway between 13.6% to 20.6% and 19% of 

votes, respectively. Prior research clearly establishes a strong association between negative 

recommendations by proxy advisory firms and subsequent voting outcomes for management 

proposals. However the precise nature of the role of proxy advisors remains unclear. 

Thomas, Palmiter and Cotter (2012) point out that proxy advisors may represent an 

aggregation of institutional investor perspectives that allow the industry to effect corporate 

governance changes in a coordinated way. From this perspective, proxy advisory firms may 

simply be an informative conduit between institutional investors and firms. However, Larcker, 

McCall and Tayan (2013) evaluate the public disclosures of the processes by which proxy 

advisors develop their voting guidelines and show that there is considerable discretion applied in 

translating the diverse feedback (using questionnaires and informal discussions) from investors 

and corporate issuers into specific voting recommendations. That is, the voting 

recommendations are not a simple tabulation of views expressed by institutional investors. 

Regardless of whether proxy advisors provide independent assessments and/or simply aggregate 

the views of institutional investors, it is important for researchers, shareholders, and regulators to 

understand whether ultimate policies that are adopted are value enhancing for firm shareholders. 

The economic implications of outsourcing voting decisions to proxy advisors are unclear 

in prior literature. Larcker, McCall and Ormazabal (2012) examine the consequences of 

designing stock option repricing programs according to proxy advisor policies and find that 

12 
296 


81762.259

programs that are constrained to meet proxy advisor criteria are less valuable to shareholders. 

Alexander, Chen, Seppi, and Spatt (2010) provide insight into the role of proxy advisors in the 

context of contested director elections. They conclude that an ISS recommendation in favor of 

the dissident slate can serve as both an indicator for the likelihood that the dissident slate is 

elected and as a certification of the value of the dissidents to shareholders. However, the setting 

of contested elections is quite different from typical proxy ballot items. In particular, the 

decision to propose opposing director slates is a relatively rare occurrence that comes from 

dissident shareholders rather than management, and proxy advisors have different processes and 

(more seasoned) research teams for evaluating contested elections and merger and acquisition 

transactions (Winter, 2010). 

2.3 Regulation of Executive Compensation and Shareholder Say-On-Pay 

Concerns and criticisms over the reasonableness of compensation levels for managers of 

publicly traded companies has been a topic of interest for journalists, politicians, and researchers 

for at least a century. Efforts to restrict executive compensation have typically utilized either 

taxes (e.g., Internal Revenue Code Regulations 162m and 280G)16 to make certain arrangements 

prohibitively expensive or increased disclosure (e.g., the 1992 and 2006 revisions for reporting 

executive compensation in the annual proxy statement or SEC Filing DEF 14A) in an effort to 

motivate boards and executives to make changes in response to pressure from shareholders or the 

public. 17 Research examining the effects of IRC 162m has shown modest effect on the form but 

not the level or performance sensitivity of executive compensation (e.g., Hall and Liebman, 

16 IRC 162m limits the deductibility of executive compensation to $1 million per year for each named executive 

officer unless the compensation qualifies as "performance-based" under the code. 280G imposes a 20% excise tax 

on "golden parachute" payments following the acquisition of the company if they exceed certain thresholds. The 

1992 and 2006 revisions to proxy reporting regulations represented substantial revisions of the disclosure regime, 

significantly increasing the tabular and narrative disclosure of compensation to named executive officers (e.g., see 

Freher, 1992, and Buck Consultants, 2006 for discussion of changes). 

17 Core, Guay, and Larcker (2008) also find little evidence that negative discussion in the press causes firms to 

reduce the level or change the mix in executive compensation. 

J3 
297 


81762.260

2000, Rose and Wolfram, 2002). In fact, some research suggests that pay levels actually rose in 

the wake of increased disclosure requirements (Murphy 1998). 

"Say-on-pay" provides shareholders with a new mechanism to influence executive pay. 

Instead of legislating particular practices, shareholders are given the opportunity to evaluate a 

firm's publicly disclosed compensation practices and provide direct feedback to boards of 

directors through a non-binding shareholder vote. With the passage ofthe Dodd-Frank Act, 

nearly all U.S. public companies are required to provide shareholders with a non-binding 

advisory vote on executive compensation beginning with annual shareholder meetings occurring 

on or after January 21, 2011. 18 Shareholders are asked whether they approve of the executive 

compensation programs as disclosed in the Compensation Discussion and Analysis (CDA) of the 

annual proxy statement. Prior to the Dodd-Frank Act, U.S. firms that received federal assistance 

under the Troubled Asset Relief Program (TARP) were required to provide SOP proposals to 

shareholders. However, for other firms, providing shareholder SOP voting was voluntary. 19 

Cai and Walkling (2011) examined the market reaction to the passage ofa say-on-pay bill 

in the House of Representatives and found that firms with excess compensation saw a positive 

market adjusted return, suggesting that shareholders believe this monitoring mechanism would 

be effective. However, Cai, and Walkling (20 II) also find that firms that are targeted by labor 

unions with shareholder proposals on executive compensation experienced a negative reaction to 

18 In its final rule on SOP, the SEC provided a temporary exemption to the SOP requirement for companies with a 

public float less than $75 million. These firms will be required to implement SOP votes in annual meetings on or 

after January 21, 2013 (see: http://www.sec.gov/news/pressl201I1201I-25.htm). 

19 SOP related activity has been increasing in recent years, beginning with shareholder pressure on firms to 

implement SOP votes through the shareholder proposal process, voluntary adoptions and requirements for T ARP 

participants. In 2007 (2008) there were approximately 50 (90) shareholder proposals calling for SOP votes which 

garnered average support of40.8% (41.7%) in favor. In 2008, Aftac, Inc. and RiskMetrics Group, Inc. (then the 

parent company ofISS) submitted SOP votes to shareholders. In 2009, TARP participants were required by the 

American Rewvery and Reinvestment Act to provide a SOP vote, and other companies, notably Verizon 

Communications Inc. and Motorola, Inc. voluntarily introduced SOP votes after shareholder proposals received 

majority support (Hodgson 2009). 

14 
298 


81762.261

the proposal disclosures. This result may indicate a potential cost if certain shareholders and 

activists are able to use the mechanism to possibly pursue an agenda different from making 

decisions to increase shareholder value. In contrast, Larcker, Ormazabal, and Taylor (20 II) find 

that stock market reactions to the SOP provision in Dodd-Frank Act are decreasing in CEO pay 

levels. This suggests that observed compensation choices are the result of value-maximizing 

contracts between shareholders and management, and broad government actions that regulate 

such governance and compensation choices are value destroying. 

While the Dodd-Frank Act represents the first time that U.S. companies have been 

required to provide a SOP vote, a similar non-binding vote structure has been in place since 2002 

in the United Kingdom. 2o Carter and Zamora (2009) and Alissa (2009) find that negative votes 

are associated with measures of excess compensation, and that boards respond to negative votes 

by reducing excess salary levels and by forcing out highly paid CEOs. Ferri and Maber (2013) 

find that firms adjust contractual features and increase the sensitivity of pay to performance in 

response to negative voting outcomes. However Conyon and Sadler (2010) did not find any 

change in the overall level of executive payor its rate of growth subsequent to SOP votes. 21 

Thus, whether SOP produces compensation contracts that are more desirable from the 

perspective of shareholders remains an important and unresolved question. 

20 In 2003, Netherlands required companies to submit compensation policy changes to a binding vote. In 2005, 

Sweden and Australia both adopted requirements for non-binding shareholder votes on remuneration reports. It is 

noteworthy that each of these countries has significant requirements for pay disclosure. Norway, Spain, Portugal, 

Denmark and, most recently, France, have followed suit. In Canada, as of the end of April 2009, 12 of the country's 

largest companies have agreed to give their shareholders a non-binding vote on executive compensation. In 2013, 

voters in Switzerland passed a referendum requiring a binding SOP vote and German legislators have promised 

legislation giving investors more control of executive pay. 

21 U.S. shareholders have also historically had the ability to influence corporate governance outcomes, including 

executive compensation, outside of SOP votes. For example, Del Guercio, Seery, and Woidtke (2008) examine 

boards' response to shareholders withholding votes for director candidates and find evidence that they are associated 

with subsequent governance improvements. Ertimur, Ferri, and Muslu (20 II) also examine director voting and nonbinding shareholder proposals and find that targeted firms with high excess CEO pay see greater shareholder support 

for the proposals and subsequently reduce CEO pay. 

15 
299 


81762.262

2.4 Institutional Shareholder Services Say-on-Pay Voting Policies 

In order to understand the ISS process for detennining SOP voting recommendations, 

we reviewed the ISS 2011 U.S. Proxy Guidelines (ISS, 20 11 a) and a sample of other research 

reports purchased directly from ISS. ISS notes three primary considerations that can result in a 

negative SOP recommendation: misalignment between CEO pay and perfonnance, problematic 

pay practices, and poor communication and responsiveness to shareholders. In addition, ISS 

evaluates five components of executive pay and assigns each either a high, medium or low level 

of concern. The five categories are (1) Pay for Perfonnance Evaluation, (2) Non-PerfonnanceBased Pay Elements, (3) Peer Group Benchmarking, (4) Severance/CIC Arrangements, and (5) 

Compensation Committee Communication and Effectiveness (ISS, 20IIb). 

The ISS "Pay for Perfonnance Evaluation" conducts an initial screen based on recent 

total shareholder return (TSR). The screen first considers whether the one-year and three-year 

TSR are below the median of all the finns in the same four-digit Global Industry Classification 

Standard (GICS) code. Ifboth the one and three year TSRs are below the corresponding 

medians of the GICS group, ISS examines whether the total compensation of a CEO who has 

served for at least two full fiscal years is aligned with total shareholder return over time (ISS, 

20 II a). The primary measure for evaluating alignment of CEO compensation highlighted in ISS 

reports is the one-year change in total compensation. 22 ISS also considers other elements of 

CEO pay alignment, including a graphical presentation oftotal CEO compensation and TSR over 

the previous five years and the percentage of equity compensation that is "perfonnance-based" 

22 In defining "total compensation", ISS closely follows the presentation of the summary compensation table, and 

includes a combination of realized pay (e.g., salary, bonus payments, cash long-term incentives) and the expected 

value of awards that will be earned in the future (e.g., stock options, restricted stock). 

16 
300 


81762.263

(i.e., where the vesting of awards is contingent on meeting performance targets). 23 In the "NonPerformance-Based Pay Elements" analysis, ISS evaluates the reasonableness of elements they 

consider not performance based, including the value of perquisites, existence and cost of tax 

gross-ups on perquisites and non-qualified pension plans, and accumulated present value of 

pension obligations to the CEO. In their policy document (ISS, 2011a) ISS also notes that they 

consider repricing underwater stock options without shareholder approval a problematic pay 

practice that could result in a negative recommendation. 

In their "Peer Group Benchmarking" analysis, ISS considers whether the firm's choice of 

peer companies and the target pay positioning against those peer companies are appropriate. The 

"Severance/CIC Arrangements" analysis identifies problematic features in severance and changein-control (CIC) contracts for executives. In its policy document (ISS, 2011a) ISS identifies 

three features of new or extended CIC arrangements that they view as problematic: (I) payments 

exceeding three times the sum of salary and bonus; (2) payments made in the absence of 

involuntary job loss (i.e., single-trigger contracts); and (3) the provision of gross-up payments to 

offset golden-parachute excise taxes. The "Compensation Committee Communication and 

Effectiveness" analysis evaluates the disclosure of executive compensation in the proxy 

statement (which includes the role of the CEO in setting pay, disclosure of performance targets 

and compensation benchmarking practices) and the Board's responsiveness to investor input on 

compensation issues (which includes responses to majority-supported shareholder proposals and 

significant opposition to SOP votes) (ISS, 2011a). 

2.5 Glass, Lewis & Co. Say-on-Pay Voting Policies 

23 It is interesting to point out that ISS and GL do not consider stock options or restricted stock with time-based 

vesting (which is the most common vesting criteria) to be performance-based pay elements. 

17 
301 


81762.264

Glass Lewis provides significantly less information on their policies in public 

documents. 24 Based on the available information, GL appears to use metrics that are similar to 

ISS in their SOP recommendation. However their approaches for determining an ultimate vote 

recommendation generate different results in many cases. 25 Specifically, GL organizes their 

analysis of executive compensation into three sections, "Pay-for-Performance", "Structure", and 

"Disclosure". Their proprietary "Pay-for-Performance" model results in a letter grade (A, n, C, 

D, or F) for each firm. The analyses of compensation "Structure" and "Disclosure" result in 

ratings of "Poor", "Fair" or "Good" (GL, 2012) 

To determine their "Pay-for-Performance" rating, GL compares a firm's compensation to 

a peer group of firms developed using a proprietary computation. They then compare the 

percentile ranking of the firm against the peer group companies in two compensation metrics 

(CEO total compensation and total compensation of the top five executives) and seven 

performance metrics (stock price change, change in book value per share, change in operating 

cash flow, EPS growth, total shareholder return, return on equity and return on assets) over the 

prior one-, two- and three-year periods. Their model generates a weighted average compensation 

percentile and a weighted average performance percentile, and the difference between those 

values is referred to as the "pay-for-performance gap". The firm is then given a grade based on a 

forced grading curve (e.g., with the I 0% of firms with the highest gap receiving an "F" and the 

24 Unlike ISS, GL does not generally provide researchers with a means of accessing their proxy reports. We 

requested access to GL proxy reports for this study, but GL responded that they had provided their reports to other 

academics on an exclusive basis. GUs proxy recommendation policy document (GL 2011a) also does not provide a 

detailed description of their process for determining recommendations. Therefore, we rely on GL reports obtained 

from web-based searches and the discussion ofGL policies in Ertimur, Ferri, and Oesch (2013) which is based on 

the actual GL proxy reports. 

25 Ertimur, Ferri, and Oesch (2013) report that ISS and GL make the same recommendation 77.0% of the time. 

However, conditional on at least one of the firms making a negative recommendation, they agree only 17.9% of the 

time. This is consistent with our findings. We find that the unconditional agreement is 78.6% and conditional on at 

least one negative recommendation it is 22.5%. This is in part due to GL issuing almost twice as many negative 

recommendations as ISS, but even within the subset of firms receiving a negative recommendation from ISS, we 

(Ertimur, Ferri, and Oesch, 2013) find that the rate of agreement is only 48.1% (44.4%), indicating that although the 

model inputs are similar, the algorithms do have distinct features. 

18 
302 


81762.265

10% with the lowest gap receiving an "A" (OL, 20 II b)). OL does not provide details of its 

analysis ofthe "Structure" category in its public policy documents. Ertimur, Ferri, and Oesch 

(2013) report that more than fifty different features of compensation programs are cited, and that 

the five most common items are (respectively) a lack of c1awback provisions, limited 

performance-based nature of incentive plans, various types oftax gross-ups, controversial 

features in CIC plans, and lack of ownership requirements. 

Similar to the "Structure" analysis, OL does not provide details of how it determines its 

"Disclosure" rating in its public policy documents. However, the two primary concerns driving 

Poor ratings for "Disclosure" appear to be lack of disclosure of performance metrics or goals and 

lack of disclosure of how equity awards are determined. 26 

3. Sample 

Our initial sample consists of all firms included in the Russell 3000 index during 20 I O. 

Since the composition of this index varies slightly across calendar quarters, our initial sample is 

composed of firms that appear in at least one quarter (n 3,062). We focus on companies that 

held their shareholder meeting in 2011, have data available in Compustat, CRSP, Equilar (the 

source of our compensation data), and Voting Analytics. We also exclude firms that held their 

shareholder meeting before January 21, 2011 and smaller reporting entities (public float ofJess 

than $75 million) because those firms were not required to conduct a SOP vote in this period. 

We focus on companies that filed their proxy statement in the first half of 20 II because actions 

preceding later shareholder meetings might be confounded by the actions taken by competitors in 

26 Similar to the findings in the ISS evaluation, Ertimu, Ferri, and Oesch (2013) find that a poor score in the pay-forperformance model ("D" or "F") was associated with the most negative recommendations (89.2%). Other features 

that they document leading to negative recommendations include lack of performance-based equity plans, various 

types of tax gross-ups, controversial features in change of control plans, discretionary elements of pay, and lack of 

clawback provisions. 

19 
303 


81762.266

response to SOP and because during those months ISS announced changes in its voting policies 

for the 2012 proxy season. Finally, we require the firms to have an available ISS SOP 

recommendation and a CEO with tenure of at least two years in order to allow for a comparison 

of changes in CEO pay and firm performance. Our selection process produces a final sample of 

2,008 firms. 

Table 1 presents descriptive statistics of the sample firms and the 4,513 firms in the 

CRSP-Compustat universe with fiscal-year end dates from 6/30/2010 to 3/31/2011. The 2,008 

sample firms capture approximately 71 % of the market capitalization of this benchmark group. 

The mean (median) market capitalization of the sample firms is 5,982 (1,173) million dollars 

compared to the mean (median) market capitalization ofthe firms in the CRSP-Compustat 

universe of 3,750 (499) million dollars. We find that our sample firms also have a lower book-tomarket ratio, lower return volatility, and higher percentage of shares owned by institutions than 

the benchmark group. In terms of industrial sectors as defined by Fama and French groups, we 

find that the industry affiliation of the sample firms is similar to that of the benchmark group 

(Table 1, Panel B). 

4. Determinants of Proxy Advisory Firm Say-on-Pay Recommendations 

4.1 Proxy advisory firm Say-on-Pay recommendations 

We collect the ISS SOP voting recommendations from the ISS Voting Analytics 

database. We construct ISS_against as equal to one if the ISS recommendation was against SOP 

and zero otherwise. ISS recommended against 13% of the firms in our sample (Table 2, Panel 

A). Glass Lewis' recommendations are not publicly available. However, it is straightforward to 

infer GL recommendations from the voting behavior offour funds that publicly disclose that 

their SOP vote follows GL policies: Charles Schwab, Neuberger Berman, Loomis Sayles, and 

20 
304 


81762.267

Invesco (confirmed by each fund's proxy voting policies included in their 2011 Statement of 

Additional Information). We collect the SOP voting decisions of these four funds from SEC 

Form NPX disclosures and find that they vote in the same way in the vast majority of cases. 27 

We construct GL _against as equal to one if those funds vote against the SOP proposal and zero 

otherwise. We find that GL recommended against 21 % of our sample (Table 2, Panel A), which 

is considerably more aggressive than ISS, and consistent with the level of opposition reported by 

GL (Glass Lewis, 2012). 28 As might be expected, ISS and GL recommendations are highly 

correlated. ISS and GL recommendations coincide in approximately 79% of the cases, but they 

differ in 395 cases out of 1849 observations for which we have both ISS and GL 

recommendations (Table 2, Panel B). It is also interesting to note that no firm that received a 

positive ISS recommendation failed to pass the SOP proposal, whereas for GL one firm that 

received a positive GL recommendation did not obtain a majority support from shareholders. 

4.2 Proxy advisory firm SOP policies 

As discussed in Section 2, ISS and GL provide public information about their SOP voting 

policies. This information enables firms to make an "informed guess" about the likelihood of 

receiving a negative voting recommendation before their proxy statement is drafted, and possibly 

before the fiscal year end. However, an interesting question is whether proxy advisory firms 

actually make recommendations in a manner consistent with their public disclosures. 29 

27 The voting decisions of Charles Schwab, Neuberger, Loomis, and Invesco only differed in six cases. In these few 

cases of disagreement, we code the Glass Lewis SOP voting recommendation using the majority vote across these 

four funds. As a robustness check, we also coded these differences as missing and obtained virtually identical 

results. 

28 We were not able to construct the GL_against variable for 159 companies as the result of missing data in the NPX filings of the target funds. 

29 Larcker, McCall, and Ormazabal (2012) find that the ISS public description regarding the metrics used to develop 

voting recommendations on stock option exchanges is highly consistent with their actual recommendations, 

Although this might be expected for a relatively simple compensation program, it is not clear whether similar 

consistency should be expected for the more complicated SOP recommendation, 

21 
305 


81762.268

Based on a reading ofISS and OL material in the public domain, the primary explanatory 

variable used in the SOP recommendation models is whether a compensation plan exhibits an 

appropriate relationship of pay-for-performance (P4P). Consistent with these disclosures, we 

construct P4P as an indicator variable that equals one (and zero otherwise) if (i) the CEO's 

compensation increases from 2009 to 2010, (ii) total shareholders' returns in the last year 

(TSRI Y) is lower than the median TSRI Y for companies in the same OICS code, (iii) total 

shareholders' returns in the last three years (TSR3y) is lower than the median TSR3Yamong the 

companies in the same orcs code, and (iv) the CEO's total compensation is above the median 

compensation of the peer companies (the peer group is defined following ISS's criteria). 10 We 

compute CEO compensation in a manner similar to the ISS and OL guidelines. Specifically, 

CEO compensation is the sum of salary, bonus, all other compensation, change in the pension 

value and earnings from non-qualified deferred compensation, non-equity incentive plan 

payouts, and the grant date value of restricted stock and the Black-Scholes value of stock option 

grants. For our sample, 13% of the firms fail this pay-for-performance assessment (Table 2, 

Panel A).3! 

In addition to pay-for-performance (P4P), proxy advisors' voting policies include a 

variety of other criteria. While these additional inputs (e.g., tax gross ups) are very difficult to 

collect for a large sample, we develop five additional measures that are noted as part of the 

30 While both finns (and GL in particular) describe more complicated evaluation algorithms, they do not provide 

sufficient detail in their public disclosures for us to precisely replicate their approach. While a simplification, our 

P4P variable captures the essential features of the CEO's relative pay and perfonnance described in the proxy 

advisor policies. As we show in this Section, P4P is significantly associated with the voting recommendations of 

both finns. However, the explanatory power is lower than would be expected if we were able to closely replicate 

their models. 

31 As a robustness check, we also construct variants of the pay-for-perfonnance assessment. First, we exclude the 

condition that TSRJ Y is lower than the median TSR3 Yamong the companies in the same GICS code. Second, we 

add the condition that total shareholders' returns in the last five years (TSR5Y) is lower than the median TSR5Y 

among the companies in the same GICS code. The results are similar, but weaker, partly because the latter 

condition induces some sample attrition (200 observations). We use the metric in the text because it is closest to the 

approach used by ISS and GL. 

22 
306 


81762.269

:rall evaluation process by proxy advisory firms. PayDisparity is the ratio between CEO 

npensation and the average compensation of the other named executive officers (NEOs). As 

sented in Table 2 (Panel A), the mean (median) ratio of CEO pay to average NEO pay is 2.76 

;1). PctLTincentives is the present value oflong-term incentives divided by the sum of the 

sent value of both long term and short term incentives. We define long-term incentives as 

tricted stock, stock options, and incentive plan awards with a performance period greater than 

~ year. Short-term incentives are incentive plan awards with a performance period of one yeaJ 

less. The mean (median) percentage of total incentives that is long-term in nature is 62% 

%). PctPBincentives is the present value of performance-based equity incentives divided by 

sum of the present value of both performance-based and non-performance-based equity 

entives. Performance-based equity incentives are performance-contingent stock options, 

tricted stock and stock unit awards, in which the number of shares and/or the vesting event is 

Jtingent upon the firms' performance. Consistent with proxy advisory assumptions, nonformance based equity incentives include restricted stock and stock options that are not 

Itingent on company performance. The mean (median) ratio of performance-based to nonformance-based equity incentives is 32% (0%). nPMis the number of performance measures 

d in performance-based long-term incentives awarded to the CEO. The mean (median) 

nber of measures is 2.39 (2.00). Based on the public disclosures and commentaries by proxy 

isory firms, we expect P4P, PayDisparity to have a positive association with the probability 

'Cceiving a negative SOP recommendation, and PctLTincentives, PctPBincentives and nPMto 

e a negative association with the probability of receiving a negative SOP recommendation. 

Proxy advisors can also include other factors into their recommendations that are not 

Jlicly disclosed or difficult to quantify (e.g., "analyst expertise"). In an attempt to partially 

23 
307 


81762.270

address this measurement or model specification problem, we include two additional variables in 

our analysis. We measure ISS degree of concern about the firm's compensation practices using 

their compensation GRId score. 32 Specifically, GRIdJomp equals one, two, or three if the 

compensation GRId score computed by ISS is labeled as "high risk", "medium risk", and "low 

risk", respectively. ISS considers 21 % of our sample companies to be "high risk." We also 

measure an assessment of general governance practices using WithholdRec which is computed as 

the number of "withhold" or negative recommendations issued by ISS on directors ofthe 

company in the previous proxy vote. The mean (median) number of withhold recommendations 

is 0.13 (0.00). 

4.3. Results 

To test whether the SOP policies disclosed by proxy advisors are associated with their 

recommendations we estimate the following pro bit regressions: J3 

Against = Jo + J 1 P4P + <, 

Against = Jo + JI P4P + () OtherCriteria + s, 

(Ia) 

(I b) 

where Against is either ISS_against or GL _against and OtherCriteria include PayDisparity, 

PctLTincentives, PctPBincentives, nPM, GRID Jomp, and WithholdRec. 

The estimation results for equations (I a) and (lb) are presented in Table 3 (Panel A and 

B show results of ISS and GL recommendations, respectively). The statistically positive 

coefficients of P4P in both panels indicate that proxy advisory firms rely on their stated pay-for32 GRid (which stands for "Governance Risk Indicator") was the ISS rating system to assess governance risk in 

201 J. The GRId score provided one of three ratings ("Low Risk", "Medium Risk", and "High Risk") in four 

governance categories (Audit, Board, Compensation and Shareholder Rights). ISS stated that they measured "longterm governance risk," but did not provide further detail on exactly what governance risk is or what outcomes would 

be associated with that risk. We collect GRId scores from publicly available sources (e.g., 

http://finance.yahoo.coml) in June 0[201 I. 

33 Firm level subscripts have been suppressed throughout the text. Unless noted otherwise, all regressions are crosssectional analyses. We also estimate equations (Ja) and (Ib) using logistic regressions and OLS and obtain very 

similar results. 

24 
308 


81762.271

performance criterion to issue SOP voting recommendations. However. the explanatory power 

for this P4P model is relatively modest (approximately 14% and 3% for ISS and GL, 

respectively). The marginal effects of P4P on JSS_against and GL~against are, respectively, 

24% and 20%, which means that, on average, meeting the P4P criteria is associated with roughly 

a 20% increase in the probability of obtaining a favorable recommendation. 

When other potential criteria for the voting recommendation are included in the 

specification, the explanatory power improves to approximately 21 % and 9% for ISS and GL, 

respectively. As expected, we also find that PayDisparity and WithholdRec have positive 

coefficients for both the ISS and GL models. GRID~ comp exhibits a negative coefficient, 

suggesting that the higher ISS rates the firm's compensation practices, the more favorable the 

SOP voting recommendation. As expected, the coefficient on PctPBincenfives is negative, 

although not statistically significant. Thus, consistent with their public disclosures, pay-for 

performance and selected other criteria are statistically important determinants of the proxy 

advisory SOP recommendations. The results in Table 3 are important because they provide 

insight about what changes firms can make to reduce the probability of obtaining a negative 

recommendation. 

5. Vote Outsourcing to Proxy Advisors 

5,1 Shareholder voting outcomes 

We compute the voting support of the SOP proposals (PctSuppori) as the percentage of 

votes in/avor of the SOP proposal based on each firm's reported voting outcomes. For example, 

some firms report percentage of votes in favor with respect to the sum of votes in favor and 

against. while other firms also include abstentions (exchange rules prevent broker non-votes 

from being counted as votes in favor of SOP. and they are typically excluded from the SOP 

25 
309 


81762.272

voting results altogether).34 We also identify firms that failed to obtain a majority suppOtt for 

their SOP proposals using an indicator variable (Fail), that takes the value of one if PctSupport < 

50% and zero otherwise. Most companies obtained a very high percentage of favorable votes for 

their initial SOP vote. Specifically, the mean (median) SOP proposal was backed by 90.6% 

(95.3%) of the votes. Only a small percentage (1.6%) failed to obtain majority support from 

shareholders (Table 2, panel A). 

5.2 Proxy advisory firm influence 

Boards of directors are likely to respond to proxy advisory firms only when they can 

actually influence substantial numbers of shareholder votes. If the firm has very limited 

institutional ownership, ISS and GL recommendations might be largely irrelevant to the board of 

directors. 35 Similarly, if institutional investors do not follow proxy advisory firm 

recommendations, these firms will have limited influence on the company. In order to 

incorporate these features into our analysis, it is necessary to develop a measure for the likely 

influence of proxy advisors on the voting by institutional shareholders for each firm confronting 

a SOP vote. 

Using voting data from the ISS Voting Analytics database, we compute for each firm the 

expected percentage of institutional votes that will follow ISS voting recommendations 

(ISi'Unjluence). We first calculate the proportion of times that each institution holding shares in 

a given firm votes with ISS when there is disagreement with management on any proposal from 

)4 To compute the percentage support to shareholder proposals) 50,79%, of our sample companies divide the number 

of votes in favor of the proposal by the sum of the votes in favor and against the proposal, 48.71% include the 

abstentions in the denominator, and 0.51 % uses the total number of shares outstanding in the denominator. To 

ensure that our results are not sensitive to this cross-sectional variation in reporting voting results, we re-estimate 

equation (2) applying each one ofthcse three ways afmeasuring voting support to all sample finns. Our inferences 

do oot change. 

55 This statement may not be true if individuals comprise a large percentage of shareholders and they arc influenced 

by proxy advisory firms. However, individuals do not generally have easy access to the ISS and GL SOP 

recommendations because they are not typically publicly disclosed aod subscriptions to the reports may be 

expensive to individual who do not realize the compliance benefits of the proxy advisors. 

26 
310 


81762.273

2003 to 2010 in the ISS Voting Analytics database. We then collect the percentage ownership of 

the finn for each institution from the Thomson-Reuters Mutual Fund Holdings database ofN30-

D filings. 36 Finally, we multiply each institution's percentage ownership in the firm at the end of 

fiscal year 20 I 0 by that institution's implied probability of voting with ISS if there is 

disagreement between the management and ISS. ISS _influence for a specific firm is the sum of 

the resulting measures across all institutions holding shares in that firm. 

The mean (median) value of our measure of ISS influence is 8.84% (8.40%). This 

influence level is lower than the observed innucnce on the average vote outcome because not all 

users of proxy advisor services are captured in the cross section of the Voting Analytics and 

Thompson-Reuters databases. For example, pension funds or university endowments may 

subscribe to proxy advisors' services, but because they arc not mutual funds, they are not 

required to report their voting record on Fonn NPX. Nonetheless, these values confinn that a 

sizable percentage of institutional votes follow ISS recommendations in cases of disagreement 

with management recommendations. In principle, it is possible to construct a similar influence 

measure for GL. Howevcr, sincc historical GL recommendations on all proposals are not 

available, we are not able to eompute a similar GL influence measure. 

We also use the percentage of finn shares owned by institutions (Pctlnstif) as alternative 

proxy for the influence of proxy advisors in the finn, We compute this variable collecting data 

from the Thomson-Reuters database of J 3-F filings. Although this variable does not capture the 

propensity of institutional shareholders to follow proxy advisors' recommendations (because 

voting data is not publicly available for all institutions), it includes holdings by institutions other 

than mutual funds that could also be subject to proxy advisory influence. 

36 This database is also referred to as CDAlSpectrum S 12 mutual fund holding database. The Spectrum data file 

contains information on quarterly equity holdings for mutual funds registered with the SEC. 

27 
311 


81762.274

5.3 Results 

To assess the impact of ISS and GL on SOP votes, we estimate (using double-censored 

regression and the variables previously defined) various forms of the following general model: 

pc/Support = iio + i5 j ISSagains/ + (52 ISS_influence + 

iiJ ISS_influence xISS __ against L (2) 

The estimated intercepts in Table 4 (Panel A) show that firms with a positive recommendation 

from ISS and low ISS influence on institutional shareholders reccivc wcll in excess of 90% 

favorable votes. In column (I), the coefficient on ISS_against is -(LlS (t-stat. = -25_68) which 

suggests that a negative ISS recommendation decreases the percentage of favorable votes by 

about 25%. This estimate, along with the high explanatory power of this model (Pseudo R2 = 

49.21 %) is consistent with the interpretation that ISS recommendations exert a substantial 

influence on SOP shareholder voting. However, the results in column (3) reveal that the effect of 

a negative recommendation significantly depends on the proxy advisor's influence on the 

company. Specifically, the interaction bctween ISS_influence and li:;S_against is -0.01 (t-stat. = 

-6.67). This estimate suggests that, conditional on receiving a negative ISS SOP 

recommendation, two firms in the 25th and 75th percentile of ISS_influence (5.18 and 11.84, 

respectively) will exhibit a difference of 6.66% in voting support for their SOP proposals. Table 

4 also shows that the results are similar when PclInslit is used as alternative proxy for proxy 

advisory influence. which suggests that it is unlikely that our inferences arc confounded by 

measurement error in our measure of proxy advisory influence_ 

for reasons discussed above, we cannot estimate equation (2) using a direct measure of 

GL influence. Howevcr, we find that a negative GL recommendation is statistically associated 

with an 18% decrease in favorable SOP votes (Table 4, Panel 8). When both ISS and GL 

recommendations arc included in the model, both coeftlcients are negative and statistically 

28 
312 


81762.275

significant. The estimated coetlicients suggest that when both ISS and GL have negative SOP 

recommendations, the favorable votes for SOP decrease by approximately 34%. Finally, when 

we use Pc/Instit as an indirect measure ofGL influence. we find in column (3) that voting 

outcomes are increasingly negative when institutional ownership is higher. Overall, the results 

in Table 4 provide evidence that proxy advisory finn recommendations can substantially shift 

SOP votes. 37 

6. Board of Director Responses to Proxy Advisors Policies 

6.1 Compensation changes before ISS recommendations 

Using the discussion in Sections 2 and 4, we first identify compensation plan changes 

that are unambiguously viewed as positive practices in the context of the proxy advisory firm 

SOP voting policies. We exploit the fact that any new or substantially changed executive 

compensation plan must be publicly disclosed on SEC Form 8-K. This regulatory requirement 

provides an explicit announcement date for estimating excess returns associated with 

compensation plan changes. 18 An important advantage of this date is that 8-K filings only 

include the items or transactions being reported and the associated announcement date is less 

confounded with other information than periodic reports such as I O-Ks and proxy statements. 

However, since executive compensation changes are likely to be an outcome of board meetings, 

it is possible that the 8-Ks are confounded by other decisions being reported from the same 

meeting. For this reason, we limit our sample to 8-Ks that do not contain other nonIn untabulatcd results, we also find that ISS influence increases the probability of failing to obtain majority 

support given a negative recommendation. Specifically, in a probit regression of Fail on ISSjnjluel1ce for the finns 

that receive a negative ISS recommendation, we find thatthe coefficient on ISS )njluence is 0.07 (t-stat. ~ 3.72). 

The marginal effect and the effect at the mean for ISSinjluence are. respectively, 1.37% and 1.52%. Using the 

same subsample of firms, we also regress Fail on GL_against. The coefficient on GL_against is 1.74 (t-stat. 

4.51). The marginal effect and the effect at the mean for GL against are. respectively, 28.6% and 24.41 %. These 

results confirm that GL recommendations also determine the probability of failing the SOP proposal. 

38 Pursuant to the Form 8-K Generallnstructions (http://www.sec.gov/about/forms!form8-k.pdD, ifan 8-K is 

required, it must be tiled or furnished within four business days after the occurrence of the event. 

29 
313 


81762.276

compensation related information (discussed below). If these changes are induced by proxy 

advisors, the observed excess return can be interpreted as the impact of proxy advisory finn SOP 

policies and voting recommendations on shareholder value. 

We collect compensation changes reported on form 8-K during the eight months prior to 

the 2011 proxy statement release date for our sample. This window was chosen for two reasons. 

First, changes in months closely following the prior year's annual meeting could be a response to 

the previous year's annual meeting and thus unrelated to future SOP considerations. Second, as 

most of our sample is comprised offlmls with calendar fiscal year ends, the eight month window 

starts approximately at the same time as Dodd-Frank was signcd into law (July, 2010). 

Since we are interested in the market's reaction to compensation disclosures, we also 

exclude 8-Ks that include other important events such as executive hires or tenninations and/or 

announcements related to other governance mechanisms (e.g. auditor changes or removal of a 

poison pill), which might confound our rcsults.39 To execute this data collection, we utilize a 

comprehensive database of 8-K filings from Equilar, Inc" which includes a categorization of the 

contents of each 8-K, allowing us to identify the subset of 8-K filings that meet our criteria. This 

selection procedure produces a sample or733 8-Ks for our 2,008 finns, with 606 flnns having at 

least one 8-K (the maximum number of 8-Ks for a single finn is three). 

Each 8-K filing was rcad and compensation features that are unambiguously aligned with 

proxy advisor policies were identified. Specifically, we determine whether each 8-K discloses 

any of the following (see Appendix A for examples and the rationale for these choices): 

additional restrictions to equity plan(s) (10 observations), amendments to outstanding equity 

}9 Because firms often aggregate compensation decisions (for instance., base salary, bonus and performance-based 

equity awards may be determined at the same time) it is not possible for us to confine the sample to only changes 

that are favored by proxy advisors. We utilize a sample of out-of-period tilings to mitigate the concern that such 

decisions are confounding our results. 

30 
314 


81762.277

awards to add perfonnance-based vesting or other holding requirements (I), new cash long-term 

incentive award(s) (21), reduction in CEO cash compensation (5), implementation of a clawback 

policy (6), amendments to change of control plan(s) (117), new performance-based equity 

award(s) (157), and reductions in executive perquisites and benefits (12). We construct the 

variable PA _Aligned ("P A" is shorthand for proxy advisor) as the number of these compensation 

changes announced in each 8-K. We setPA_Alignedequal to zero if either there are no 8-Ks in 

our sample or the compensation changes are not those we have identified as being 

unambiguously aligned with proxy advisor SOP policies. For our sample of 8-Ks, PA _Aligned 

equals three in 2 cases (0.27%), two in 28 (3.82%) cases, one in 267 (36.43%) cases and zero in 

436 (54.48%) cases. It is important to note that the absence of a proxy advisor aligned feature 

does not necessarily imply that the compensation announcement in the 8-K would be viewed 

negatively in the proxy advisor models. Many common items, such as awarding of salary 

increases, detennination of bonus payouts and determination of bonus performance objectives 

could be either good or bad in the context of the compensation and perfonnance outcomes. 

Other items, such as minor amendments to plans or contracts to reflect tax or other legal changes 

may not enter into the evaluation. 

Although the compensation changes used to construct PA Aligned are considered desirable 

by proxy advisory firms, this does not necessarily imply that these changes are actually induced 

by ISS and GL. However, if these compensation changes are correlated with the likelihood that 

a firm will receive a negative SOP recommendation. this will provide some evidence that the 

changes arc actually influenced by proxy advisors. The crucial assumptions for this 

interpretation arc that the board of directors has a reasonable idea about the likely forthcoming 

SOP recommendation and that they believe that these changes during the time period prior to the 

31 
315 


81762.278

proxy statement release in order to improve the ultimate SOP recommendation produce a net 

economic benefit for shareholders. That is, the cost of changing thc compensation plan is less 

than the cost of receiving substantial negative SOP votes. This assumed behavior is consistent 

with the results of the recent survey conducted by The Conference 130ard, the Stanford Rock 

Center, and NASDAQ (2012) which finds that most firms reviewed proxy advisor policies and 

that those policies influenced their ultimate compensation programs presented to shareholders for 

the SOP vote. 

To explore this possibility we compare key characteristics for firms that make proxy 

advisor aligned compensation changes previous to the 2011 annual meeting to the remainder of 

the sample finns. Specifically, we focus on P4P because it is a primary determinant of the SOP 

recommendation (see Table 3) and lS~')_influence because it (along with the SOP 

recommendation) has a substantial impact on shareholder voting (see Table 4). We also include 

Pctlnstit as alternative proxy for proxy advisory influence. 

Table 5 (panel A) compares descriptive statistics of these variables for the 275 firms that 

filed 8-Ks disclosing proxy advisor aligned compensation changes in the 8 months before the 

proxy filing to the remaining 1,733 sample firms. We observe that there is a significantly higher 

proportion of firms that did not meet the P4P criterion among the finns that disclosed proxy 

advisor aligned compensation changes compared to the rest of sample firms. Table 5 also shows 

that, compared to the remainder of the sample, firms that disclosed proxy advisor aligned 

compensation changes exhibit higher levels of proxy advisory influence (measured by 

ISSinfluence and Pctlnstil). These results suggest that compensation changes desired by proxy 

advisors are more frequent in firms that are otherwise more likely to receive a negative SOP 

recommendation and where proxy advisors have substantial influence on shareholders. 

32 
316 


81762.279

Table 5 (panel A) also compares descriptive statistics of the previous variables between 

finns filing proxy advisor aligned 8-Ks and finns that filed compensation 8-Ks that did not 

contain any of the proxy advisor aligned characteristics. This analysis provides insight into the 

specific subsample of firms that we know have made changes that align their compensation with 

proxy advisor policies. Table 5 shows that the differences between these two groups are very 

similar to those described previously. These results reinforce the idea that not meeting proxy 

advisor's criteria leads to specific changes that arc aligned with proxy advisor criteria, as 

opposed to a general set of compensation changes. 

One important concern about the results in Table 5 (panel A) is that the identified pattern 

for compensation changes might be a usual phenomenon that occurs before every shareholder 

meeting, and thus not necessarily related to the SOP vote. To assess this concern, we take a 

random sample 01'773 8-Ks from previous fiscal years (from 2006 to 20 I 0) and examine 

whether this pattern of compensation-related 8-Ks is also found in previous years 40 We then 

read and manually code each 8-K with the same criteria used for the 20 II sample of 8-Ks: 

additional restrictions to equity plan (7 observations). amend outstanding awards (0), new cash 

long-term incentive plans (29), reduction in cash compensation (22), clawback (6). 

changes/amendments to change of control plans (23), new performance-based equity plans (124), 

and reduce benefits (22). The most substantive difference between the two samples is the larger 

number of adjustments to change of control plans in the more rccent time period. The most 

frequent change is the adoption of new performance-based equity plans in both time periods. For 

this random sample, PA_Alignedis greater than zero in201 (27%) cases and zero in 532 (73%) 

cases. Thus, in the random sample from the 2006-20 I 0 proxy seasons, there are substantially 

40 We code the randomization algorithm in a way that the random sample has the same number of 8-Ks every year 

and the same number affirms as the 2011 sample of8-Ks. 

33 
317 


81762.280

fewer proxy advisor aligned 8-Ks than in the sample of 8-Ks from the 20 II proxy season 

(27.28% between 2006 and 20 I 0 versus 40.51 % in 20 II). 

In contrast to the results for the 2011 proxy season, P4P and ISS_influence are not 

significantly different between 8-Ks announcing proxy advisor friendly compensation changes 

and 8-Ks announcing other types of compensation changes. The results in Table 5 (Panel B) 

provide support for the interpretation that the time period prior to the first SOP vote exhibits 

unique compensation plan changes that are related to concerns about receiving a negative SOP 

recommendation from proxy advisors. 

6.2 Compensation changes and subsequent ISS recommendations 

Another crucial assumption for our claim that companies are making compensation plan 

changes in response to proxy advisors is that these changes should improve the chances of 

obtaining a more favorable recommendation. To provide some evidence on this issue, we 

examine whether making compensation changes that conform to proxy advisors' criteria 

decreases the probability of obtaining a subsequent negative SOP recommendation. We do this 

by estimating the following probit regression: 

(3) 

where SumJ)AAligned is the sum of PA,Aligned (i.c .. the total number compensation changes 

disclosed on 8-K during the eight months previous to the 2011 proxy statemcnt that are aligned 

with proxy advisors' policies)41 We include P4P as a control for the likely proxy advisory finn 

recommendation if there were no compensation changes by the firm (i.e., if a firm fails P4P, they 

are likely to obtain a negative SOP recommendation). We find that the coefficient on 

" Forthe sample of finns, Sum,PA,Aligned equals three in five cases (0.25%), two in 44 (2.19%) cases, one in 226 

(36.43%) cases and zero in 1733 (86.30%) cases. Note that Sum PA.Aligned is measured at firm level, whereas 

PAAligned is measured at 8-K level. Thus. the distribution of Sum .PA ,Aligned differs slightly from the 

distribution of PA ~_Aligned compensation because for some finns changes are announced in more than one 8-K. 

34 
318 


81762.281

SUIn_PAAligned is statistically negative which suggesting that making compensation changes to 

align compensation programs with proxy advisors' policies reduces the probability of obtaining a 

negative SOP recommendation (Table 6). 

The second set of columns in Table 6 presents results restricting the analysis to firms that 

actually made some type of compensation change. Specifically, we include the compensationrelated 733 8-Ks and test whether the number of changes aligned with proxy advisory policies in 

each 8-K is associated with a subsequent favorable recommendation from proxy advisors. The 

results in Table 6 confirm that compensation changes conforming to ISS critcria lead to more 

favorable SOP recommendations. 

6.3 Market reaction to compensation plan changes 

To estimate the shareholder value implications of changes in compensation contracts 

made to comply with proxy advisor SOP voting policies, we examine the stock market reaction 

at the relevant 8-K filing date. If the threat of receiving a negative SOP recommendation from 

proxy advisors motivates the board of directors to remove features of compensation contracts 

that allow executives to extract rents, the market reaction to the announcement should be 

positive. Alternatively, if the influence of proxy advisor SOP policies motivates firms to deviate 

from existing optimal compensation contracts, we should observe a negative market reaction. 

We examine the market reaction to compensation changes prior the proxy statement 

release on the day when the company files the 8-K announcing the change42 Our dependent 

variable, AdjRet. is the daily risk-adjusted return on the filing day for each firm computed using 

42 We analyze 8-Ks that contain only information on compensation changes in order to minimize the chances that 

the market reaction on that day is confounded by other information. We also examine the twenty 8-Ks with the 

largest negative reaction and search in Factiva for other potentially confounding information about the finn. We do 

not identify any informational events that are likely to confound our interpretation ofthe adjusted returns. 

35 
319 


81762.282

the standard daily Fama-French model plus momentum to compute daily risk-adjusted returns. 43 

The coefficients of the risk factors are estimated using daily data over a period of -6 to +6 

months around the filing date. and the incremental intercept on the 8-K announcement date is 

used as an estimate of Adj Ret. 

To test whether the stock market reaction to the introduction of compensation changes is 

associated with the desired criteria of proxy advisory firms. we regress risk-adjusted returns on 

PA Aligned: 

(4) 

In Table 7 (panel A, column I). we find that the estimated coefficient for PA _Aligned is 

-0.444 (t-stat. = -2.91), whereas the intercept is not statistically different from zero (t-stat. = 

0.86). This result is consistent with the conclusion that compensation changes desired by proxy 

advisory firms produce a net cost to shareholders, while compensation changes not related to 

proxy advisors' criteria are value-neutral. 44 The coefficient on P A _A ligned also suggests that the 

cost to shareholders of these changes is economically significant (the estimated average decrease 

in shareholder wealth is 44 basis points per induced change). 4S When we repeat this analysis 

using the random sample of 8-Ks from prior proxy seasons, we find (Table 7, panel A, column 2) 

that the adjusted returns for compensation changes aligned with proxy advisor policies are not 

statistically different from zero. (t-stat. = 0.21). Thus, the negative stock market reaction to 

proxy advisor aligned compensation changes is only observed in the time period just prior to the 

initial SOP vote. As shown in Table 7 (panel A, column 3), the estimated difference in adjusted 

returns is -0.488 (t-stat. = -1.91). These results suggest that the observed negative adjusted 

43 We obtain similar inferences calculating average risk·adjusted returns within a (0,+ I) window around the filing. 

44 We also estimate the average adjusted return partitioning by PA Ali[;ned The average adjusted return of g·Ks 

where PA.Ali[;ned is non-zero (zero) is negative and significant (.positive and not significantly different from zero). 

45 In untabulated results, we find similar results when value-weight the excess returns. 

36 
320 


81762.283

returns are not some type of general "8-K effect'", but rather are associated with compensation 

changes made to obtain a favorable SOP recommendation from proxy advisory firms.46 

A potential concern about these results is that, even in the absence of compensation 

changes, PA_Aligned could be related to daily returns if this variable captures an omitted risk 

factor or other determinants for cross-sectional returns. To address this concern, we examine 

whether the negative adj usted returns of firms that make compensation changes related to proxy 

advisors' criteria are unique to the 8-K filing date. Specifically, we compute the average daily 

adjusted return for the 30 days before and the 30 days after the 8-K filing date and partition the 

8-K sample into those 8-Ks where PA_Aligned equals zero and those where PA_Aligned is nonzero. 47 We find that the average adjusted returns of firms that make proxy advisor aligned 

compensation changes are not systematically lower than those of firms that make compensation 

changes unrelated to those criteria before Crable 7, panel B, column I) or after (Table 7, panel B. 

column 3) the 8-K filing date. Columns 4 and 5 of Table 7, panel B show that the negative 

return associated with proxy advisor aligned 8-Ks are unique to the 8-K filing date. 48 

6.4 Moving shareholder meeting dates in anticipation of SOP 

46 Another way to assess the impact of proxy advisor SOP recommendations is to examine the market reaction to 

contractual changes disclosed t.~fier receiving a negative SOP recommendation. We have identified a small sample 

of 12 cases where firms either made changes to their compensation programs or commitments to change future 

programs after filing their proxy statement in order to garner a positive [SS recommendation and avoid failing the 

SOP vote. The 12 companies are: Assured Guaranty Ltd., The Walt Disney Company, General Electric, Gannett 

Co., Lockheed Martin, Alcoa, Collective Brands, The Providcnce Servicc Corp. Intermec, Inc., Brandywine Realty 

Trust MeadWestVaco, and Interline Brands, Inc. In untabulated results, we find that the averagc adjusted return 

within the (- J ,-1) window around the day the changes were announced for these observations is -0.30% (t-statistic 

~ 1.01). Although this sample size is small (and the power of the test is limited), this evidence is consistent with 

our prior results that compensation changes induced by proxy advisory firms have an adverse impact on shareholder 

value, 

47 We also repeat the test using shorter- and longer-windows around the 8-K dates and find consistent results. 

·1-8 We also assess which individual compensation changes induce the most negative adjusted returns. The most 

common compensation changes are new perfonnance-based equity awards (157 observations) and 

changes/amendments to change of control plans (117 observations). These two types of changes are associated with 

negative returns -0.551 and -0.103, respectively, New cash long-tenn incentive plans exhibit the largest adjusted 

return (-2. I 5). butthere are only twenty one observations for this category. All types of compensation changes 

except for reductions in benefits are associated with negative risk-adjusted returns on the day of the announcement. 

37 
321 


81762.284

As discussed in Section 2, a formal SOP vote is required for most companies with 

shareholder meetings occurring on or after January 21,2011. If revisions to compensation plans 

induced by SOP is costly to firlns (or, alternatively. personally costly to executives), we should 

see companies with shareholder meetings in the first calendar quarter that appear likely to 

receive a negative SOP recommendation moving their annual meeting to before January 21 st. 

We find that the number of firms having their meeting in the few days before January 21 st 

increased dramatically from 2010 to 2011 (see Figure I). In 2011, 37 companies decided to have 

their shareholder meeting on onc of the four days before January 21 st In contrast, only 7 firms 

had their shareholder meeting on those days in 2010. Figure 1 also shows that the numher of 

firms having their shareholder meeting on or shortly after January 21 st is significantly lower in 

2011 than in 20 I O. This concentration of sharcholder meetings immediately before January 21 5t 

20 II suggests that some finns advanced their meetings to avoid being sUhject to a SOP vote in 

2011. 

There are 194 firms in the Russell 3000 that had their meeting in the first calendar quarter 

of 2010. Interestingly, 32 of these finns had the 2010 shareholder meeting after January 21 st 

20 I 0, but their 2011 shareholder meeting before January 21 st 2011. In contrast, only 4 firms had 

their 201 0 shareholder meeting before January 21 st 201 0, hut their 2011 shareholder meeting 

after January 21 st 20 II. Moreover, we find evidence that the firms most likely to move their 

annual meeting date are those that arc more likely to fail the P4P criterion. While 28.12% of the 

32 finns that moved their meeting forward did not meet the P4P criterion, only 10.30% of the 

remaining 162 did not meet this criterion. This difference is statistically significant (t-stat. = 

2.73), and is further evidence consistent with the idea finns view SOP legislation as costly49 

49 One of the potential costs offailing to obtain the required support for SOP proposals is that the firms and board 

members can be sued on grounds of alleged breach of fiduciary duty. After the 2011 proxy season, seven companies 

38 
322 


81762.285

6.5 Alternative interpretations of the results 

Performance Signaling 

One alternative interpretation of our results is that the markct rcacts ncgatively to the 

announccment of these compensation changes not because the recontracting is suboptimal, but 

because the change signals poor future perfonnance or is indicative of other governancc 

problems that the market was unaware of. For example, boards might introduce contractual 

changes because they possess inside information that finn performance will be worse than 

expected and as a result they impose compensation risk (e.g., performance-based equity) on 

managers in an attempt to change inccntives and future performance. In this sctting, thc market 

would interpret the observed recontracting as a ncgative signal, and this has the potential to 

confound our conclusion that compensation changes induccd by proxy advisors are value 

decrcasing for shareholders. 

Although signaling is a plausible alternative interpretation. the available empirical 

evidence does not support this conclusion. Specifically, prior literature has shown that finns 

adopting perfonnance-based equity programs have historically rcalized positive future 

perfonnanee. For example Larcker (1983) finds a positive market reaction to the introduction of 

performance-based plans and Bettis, Bizjak, Coles, and Kalpathy (2010) find that companies that 

introduce perfonnanee-based featurcs in compensation contracts have lower past stock price 

perfonnance and significantly better subsequent operating performance than control finns. This 

which experienced a SOP voting failure were sued shortly ailer the shareholder meeting. To the extent that the 

voting outcome and the subsequent lawsuits were (alleast partially) unexpected by the market and the lawsuits are 

viewed as costly (e.g., either through direct costs related to the suit or the costs associated with management 

distraction), the market reaction to these events can also provide some insight into the cost implications ofthe SOP 

voting recommendations. In untabulated results. we find that the stock market reaction for firms involved in a SOP 

lawsuit is -0.50% (t-stat. = -1.58). Although this result should be interpreted cautiously because ofthe small 

number of observations (and reduced statistical power), it suggest that a negative SOP recommendation and a 

subsequent voting failure can impose substantial costs on affected. 

39 
323 


81762.286

evidence suggests that the adoption of performance-based equity plans (if anything) should be a 

signal of future good perfiJrmance, as opposed to had perfonnance. 

To provide further evidence on this point, we estimate a regression of future firm 

performance (calculated as the average of quarterly earnings deflated by total assets over the four 

quarters ending after the tiling date of the 8-K) on the explanatory variables in equation (4). In 

untabulated results, we find that the coefficient on PA_ Aligned is positive and not statistically 

significant (t-stat. = 0.59). This result is not consistent with the negative signaling explanation. 

Another related way to provide insight into the signaling story is to examine the timing of 

the 8-K filings. As discussed in Section 2, shareholder return, measured at the end of the firms' 

fiscal year, is the primary measure of finn perfonnance used by proxy advisory firms. Our 

analysis, on the other hand, considers 8-Ks filed in the 8 months prior to the proxy statement 

filing date, which is typically three to four months after the fiscal year end. As a result, 84.5% of 

our proxy advisor aligned 8-K observations occur after the fiscal year end when the relevant 

market returns are already known. If our findings were driven by a negative signaling effect, the 

negative reaction should be concentrated in the observations prior to the fiscal year end. 

However, out of the 297 filings with a potential SOP recommendation problem (i.e., where the 

variable PA _aligned 1), only 46 are filed before the fiscal year end date, and the average riskadjusted return for these 8-Ks is a statistically insignificant -0.27% (t-stat. -I. I 7). In contrast, 

the average risk-adjusted return of the 251 changes announced after the fiscal year end is a 

statistically significant -0.35% (t-stat -1.90).50 These results suggest that the negative 

reaction is concentrated in 8-Ks filed after the fiscal year end, and thus the contractual change 

does not appear to be signaling negative pertonnance for this liscal year. 

50 In contrast, for the subset of 8-Ks with PA aligned ~ 0 only 73 are filed after the fiscal year end date. The 

average risk-adjusted returns of 8-Ks filed both before and after the fiscal year end are positive. but not statistically 

significant. 

40 
324 


81762.287

Market Expectations olColl1pensation Changes 

Our interpretation of the negative risk-adjusted return associated with compensation 

changes induced by proxy advisors is that unexpected and unfavorable information is released to 

the market at the 8-K announcement date. However. a concern with this explanation is that 

investor expectations about proxy advisor and board behavior are unknown. Conceptually, the 

observed risk-adjusted return should be the difference between the value ofthe observed change 

and the value of the compensation change (if any) expected by the market. This means that the 

market must have an expectation about the value of a future compensation change and the 

probability that this change will occur. Moreover, both ofthese variables are likely to be 

influenced by the probability that the proxy advisory firm will make a negative recommendation, 

expected costs of having a substantial number of against votes, and expected cost of changing the 

compensation program. There are several reasons to believe that this is an especially difficult 

inference problem for the market. 

One complicating factor is that the market must develop an accurate expectation about 

proxy advisor recommendations prior to the 8-K filing event, which is (by construction) prior to 

the proxy statement. As we show in Table 3, it is very difficult to infer the proxy advisor 

recommendations even after considering a substantial portion of information that is available in 

the proxy statement. At the time ofthe 8-K. there is considerably less information available for 

investors to make an inference (for instance, proxy advisors evaluate the quality of proxy 

statement disclosures, which is not known until the proxy statement is actually filed). This raises 

serious questions about the market's ability to reasonably forecast proxy advisory firm SOP 

recommendations. 

41 
325 


81762.288

Even if the market can develop an accurate forecast for the recommendation, it is still 

necessary to estimate the expected costs of negative votes and the valuation of changes in the 

compensation plan which would lead to positive vote. It may be reasonable to assume that 

litigation costs or management distraction can be assessed by the market. However, private costs 

such as reputational concerns associated with a negative voting outcome and the expected costs 

(or benefits) resulting from a compensation change are likely to be very difiicult for the market 

to assess. Thus, although not completely satisfactory from a pure theoretical perspective, we 

believe that as a practical matter the market's expectation for changes at the 8-K announcement 

date are likely to be quite diffuse. 

Holding aside this conjecture about market expectations, it is possible that the market 

correctly anticipates that the firm will be exposed to the influence of the proxy advisors. 

Moreover, proxy advisor policies may be value increasing to shareholders, but the market is 

disappointed by the changes observed at the 8-K announcement (i.e., the changes do not "go far 

enough" to address compensation problems at a firm). In this scenario, we should observe a 

negative market reaction even though this outcome has nothing to do with suboptimal 

compensation changes being induced by proxy advisory firms. 

The difficulty with this alternative intcrpretation is that it is based on a market that has 

biased expectations for SOP responses by finns. As discussed above, we expect the market to be 

faced with considerable difficulty in estimating the influence of proxy advisors. but there is no 

obvious reason for the market to make systematically biased estimates of expected compensation 

changes by firms. Moreover, under this interpretation the most negative market response should 

be observed for finns that exhibit pay-for-perfonnance concerns (Y4P I) and have 8-K 

announcements with compensation changes that are not aligned with proxy advisor policies. In 

42 
326 


81762.289

untabulated results, we find a statistically insignificant positive mean risk-adjusted return for this 

subset of finns (t-stat. 0.07). Thus, we do not believe that the interpretation of our results is 

completely confounded by economic issues related to market expectations. 

Rent-Extracting Compensation Changes 

It is also possible that the compensation changes are being made by rent extracting 

managers seeking to avoid market discipline that may be imposed on them after the SOP vote. 

For example, as illustrated in Table 6, the proxy advisor aligned changes reduce the likelihood of 

a negative recommendation and receiving a positive recommendation ensured a passing SOP 

vote. If boards and managers making compensation changes are actually engaging in rent 

extraction and the market correctly anticipates that they have reduced the likelihood of facing 

market discipline by confonning to proxy advisor policies, the market would be expected to 

reduce the value of the firm. Although the mechanism by which the shareholders are harmed is 

different than our interpretation, we reach the same conclusion that the proxy advisor policies arc 

not value increasing for shareholders. 

7. Summary and Concluding Remarks 

Institutional investor voting on corporate proxies has the potential to influence a wide 

range of finn corporate governance choices. Over the past decade, the SEC and Congress have 

increased regulation focused on institutional investors voting. An explicit assumption in this 

regulation was that institutional investors would conduct the research necessary to vote in a 

manner that would maximize value for all finn shareholders. Unfortunately institutional 

investors face a classic free rider problem in conducting this research and may not have 

economic incentives to make such an investment. A significant proportion of institutional 

investors rely on proxy advisory finns to conduct research and detennine votes on their behalf. 

43 
327 


81762.290

This outsourcing of voting responsibilities can be an efficient means of sharing the costs of 

research across investors. However, if the free rider problems sufficiently dilute the benefits to 

individual institutions. it is also plausible that the outsourcing of voting responsibilities to 

institutional investors represents the lowest cost voting compliance mechanism. In such a setting 

investors are unwilling to pay more for better research into optimal vote decisions because their 

vote is not expected to have an impact on the voting outcome and there is no additional benefit 

such as using the research to impact the stock selections made by portfolio managers. 

The fundamental question is whether outsourcing votes to proxy advisors creates or 

destroys value for firm shareholders. This is important in the current cnvironment because, 

unlike the individual institution which may only control a small block of shares, proxy advisors 

aggregate a large block of votes which will follow their recommendations (34% on average for 

our sample). As such. proxy advisors can be pivotal in the outcome of a given ballot item and 

induce firms to make governance changes in response. If these voting recommendations are 

optimal, changes in firms induced by these policies will improve firm governance and benefit 

shareholders. However. if the policies are arbitrary and/or not optimal, they may induce boards 

of directors to change to less appropriate governance structures. 

We examine the sharcholder value implications of outsourcing to proxy advisory firms on 

the recent requirement to implemcnt Say-on-Pay. Using a large cross-section of finns, we 

confirn1 that proxy advisory firm rccommendations have a substantive impact on SOP voting 

outcomes. We also find that, anticipating this impact, a significant number of boards of directors 

change their compensation programs in the time period b~rore the formal shareholder vote in a 

manncr that better aligns compensation programs with the recommendation policies of proxy 

advisory finns and subsequently realize a higher likelihood of a positive vote rccommcndation. 

44 
328 


81762.291

We interpret our result as evidence that boards of directors change executive compensation plans 

in order to avoid a negative SOP recommendation by proxy advisory firms, and thereby increase 

the likelihood that the finn will not fail the vote (or will gamer a sufficient levcl of positive 

votes). The stock market reaction to these compensation program changes is statistically 

negative. Moreover, this effect is unique to the time prior to the initial SOP vote (20 II) and a 

similar stock market reaction is not observed during the 2006-20 I 0 time period. 

As with all observational studies. there are a variety of alternative interpretations of this 

result. However, we believe the most parsimonious and plausible conclusion is that the 

confluence offree rider problems in the voting decision, regulation of voting in institutional 

investors. and the decision by the SEC to regard proxy advisor policies as appropriate for 

purposes of institutional investor compliance with regulation has led to policies of proxy 

advisory firms that induce the boards of directors to make compensation decisions that decrease 

shareholder value. While our findings provide insight into the shareholder value implications of 

outsourcing proxy research in the current economic and regulatory setting, we acknowledge that 

we cannot make inferences ahout the social welfare implications of the current regulatory regime 

relative to alternatives such as a prohibition on proxy advisory firms or a reduction in items 

presented to shareholders for vote. 

45 
329 


81762.292

References 

Alexander, c., Chen, M., Seppi, D., and Spat!, C., 20 10. Interim News and the Role of Proxy 

Voting Advice. Review of Financial Studies 23, 4419-4454. 

Alissa, W., 2009. Boards' Response to Shareholders' Dissatisfaction: The Case of Shareholders' 

Say on Pay in the UK. Working Paper, Pennsylvania State University. 

Barber, 8., 2007. Monitoring the Monitor: Evaluating CaIPERS' Activism, Journal of Investing, 

16,66-80. 

Belinfanti, T., 2010. The Proxy Advisory and Corporate Governance Industry: The Case for 

Increased Oversight and Control. Stanford Journal of Law, Business and Finance, 14, 384-439. 

Bethel, J., Gillan, S., 2002. The impact of the institutional and regulatory environment on 

shareholder voting. Financial Management 31,29-54. 

Bettis, c., Bizjak, J., Coles, J., Kalpathy, S., 20 10. Stock and Option Grants with PerfonnaneeBased Vesting Provisions. Review of Financial Studies 23, 3849-3888. 

Buck Consultants, 2006. SEC Proxy Disclosure Rules: Current vs. New. Accessed April 12, 

2012 from 

http://www.shnn.org/Publications/hnnagazine/EditoriaIContent/Documents/BuckvsProxyRules. 

pdf. 

Cai, J., Gamer, J., Walking, R., 2009. Electing Directors. Journal of Finance 64, 2389-2421. 

Cai, J., Walkling, R., 2011. Shareholders Say on Pay: Does it Create Value? Journal of Financial 

and Quantitative Analysis 46, 299-339. 

Carter, M., Zamora, V., 2009. Shareholder Remuneration Votes and CEO Compensation 

Design. Working Paper, Boston College. 

Conyon, M., Sadler, G., 20 I O. Shareholder Voting and Directors' Remuneration Report 

Legislation: Say on Pay in the UK. Corporate Governance: An International Review 18,296-

312. 

Core, .I., Guay, W., Larcker, D., 2008. The Power of the Pen and Executive Compensation. 

Journal of Financial Economics 88, 1- 25. 

Craig, S. and Silver-Greenberg, J. 2013. Small Firm Could Turn the Vote on Dimon. The New 

York Times (May 7, 2013). 

Cremers, M., Romano, R., 2009. Institutional Investors and Proxy Voting on Compensation 

Plans: The Impact of the 2003 Mutual Fund Voting Disclosure Regulation. NBER Working 

Paper. 
330 


81762.293

Del Guercio, D., Seery, L., Woidtke, T., 2008. Do Boards Pay Attention when Institutional 

Investor Activists "Just Vote No"? .Ioumal of Financial Economics 90, 84- 103. 

Ertimur, Y., Ferri, F., Muslu, V., 2011. Shareholder Activism and CEO Pay. The Review of 

Financial Studies 24, 535- 592. 

Ertimur, Y., Ferri, F., Oesch. 0.,2013. Shareholder Votes and Proxy Advisors: Evidence from 

Say on Pay. Working Paper. Columbia University. 

Ferri, F .• Maber. 0.,2013. Say on Pay Vote and CEO Compensation: Evidence from the UK. 

Review of Finance 17,527-563. 

Freher, E., 1992. What the New Proxy Disclosure Rules Mean to Your Executive Compensation 

Practices. Journal of Corporate Accounting and Finance 4, I 19-125. 

Glass, Lewis & Co. (GL), 201 la. US Proxy Paper Guidelines: An Overview of the Glass Lewis 

Approach to Proxy Advice for U.S. companies. Accessed February 10.2011 from 

http://www.glasslewis.com/down loads/pol icies/U S Pol icyGuidelinesSummary20 I O.pdf 

Glass, Lewis & Co. (GL), 2011 b. Pay For Performance. Accessed May 22, 2012 from 

http://www.glasslewis.com/resources/pay-for-performance/. 

Glass, Lewis & Co. (GL), 2012. Say on Pay 20 I I : A Season in Review. 

Gillan, S., Starks, L., 2007. The Evolution of Shareholder Activism in the United States, loumal of 

Applied Corporate Finance 19(1),55-73. 

Hall, B .. and Liebman. J., 2000. The Taxation of Executive Compensation. In 1. Poterba (Ed.). 

Tax Policy and the Economy. Vol. 14 (pp. 1-44). MIT Press. 

Hodgson, 1'., 2009. A Brief History of Say on Pay. Ivey Business Journal 73, I. 

Institutional Shareholder Services (ISS). 20 II a. 20 II U.S. Proxy Voting Guidelines Summary. 

January 27,20 II. Accessed May 22.2012 from 

http://www.issgovernance.com/filesIlSS20 II USPolicySummaryGuidelines2011 0127.pdf. 

Institutional Shareholder Services (ISS), 2011 b. Tyson Foods, Inc. Proxy Voting Report. 

January 20. 2011. Accessed May 24,2011 from 

http://www.issgovemance.com/fi les/private/l SS _Tyson.pdf. 

Larcker, D., 1983. The Association Between Performance Plan Adoption and Corporate Capital 

Investment. loumal of Accounting and Economics 5. 3-30. 

Larcker. D., McCall. A., and Ormazabal, G., 2012. Proxy Advisory Films and Stock Option 

Exchanges. Working Paper. Stanford University. 
331 


81762.294

Larcker, D., McCall, A., and Tayan, B., 2013. And Then a Miracle Happens!: How Do Proxy 

Advisory Firms Develop Their Voting Recommendations') Rock Center for Corporate 

Governance at Stanford University Closer Look Series: No. CGRP- 31. 

Larcker, D., Ormazabal, G., Taylor, D., 2011. The Market Reaction to Corporate Governance 

Regulation. Journal of Financial Economics 101,431-448. 

Morgan, A., Poulsen, A., Wolf, 1., 2006. The evolution of shareholder voting for executive 

compensation schemes. Journal of Corporate Finance 12,715-737. 

Murphy, K., 1998. Executive Compensation. In O. Ashenfelter and D. Card (eds.) Handbook of 

Labor Economics, Vol. 3. North Holland. 

Rose, N., Wolfram, C., 2002. Regulating Executive Pay: Using the Tax Code to Influence Chief 

Executive Officer Compensation. Journal of Labor Economics 20, S 138-S 175. 

Securities Exchange Commission (SEC), 2003. Disclosure of proxy voting policies and proxy 

voting records by registered management investment companies. Investment Company Act 

Release No. 25922, 17 C.F.R. 239, 249, 270, 274 (Jan. 31, 2003). 

Tapestry Networks and IRRC Institute. 2012. Voting Decisions at US Mutual Funds: How 

Investors Really Usc Proxy Advisers (June, 2012). 

The Conference Board, NASDAQ, and Stanford Rock Center for Corporate Governance, 2012. 

The Influence of Proxy Advisory Firm Voting Recommendations on Say-on-Pay Votes and 

Executive Compensation Decisions. Availahle at: http://www.gsh.stanford. 

edu/ ddr/ research/ surveys/proxy. htm I. 

Thomas, R .. Palmiter, A., Cotter, J., 2012. Dodd-Frank's Say On Pay: Will it Lead to a Greater 

Role for Shareholders in Corporate Governance? Cornell Law Review 97,1213-1266. 

Winter, S., 20 I O. Trends in Shareholder Voting - The Impact of Proxy Advisory Firms. 

American Bar Association Corporate Governance Committee. 

81762.295

Appendix A. Compensation changes aligned with proxy advisor' voting policies 

Feature Description Rationale 

New Performance- The award of equity compensation (stock options, ISS' policies explicitly consider the performance-based vs. no

Based Equity Plan restricted stock or restricted stock units) in which the performance-based pay ratio. Equity awards that do not have 

vesting event and/or the number of shares earned is performance contingencies are not considered performance-b

contingent on the achievement of pre-determined (ISS 2011 a). GL views the lack of performance-based long-t

performance objectives where comparable awards were incentives as a concern which was cited in 41 % of its negativ

not granted in the prior fiscal year. recommendations. 

New Cash Long-Term Award of new cash bonus opportunities in which the ISS' policies explicitly consider the performance-based vs. no

Incentive Plan bonus is earned based on the achievement of performance-based pay ratio. Equity awards that do not have 

performance objectives measured over a period greater performance contingencies are not considered performance-b

than one year where comparable awards were not (ISS 20 II a). GL views the lack of performance-based long-t

granted in the prior fiscal year. incentives as a concern which was cited in 41 % of its negativ

recommendations. Also, because cash-based plans are includ

compensation when they are earned rather than when they are 

«warded in both the ISS and GL computations of pay, a new 

term cash plan will reduce pay in the current year relative to a 

comparable equity award. 

Restrict Existing Amendments to existing equity compensation ISS and GL oppose stock option repricings conducted withou

Equity Plan(s) programs that restrict or eliminate features that are in shareholder approval (Larcker, McCall, and Ormazabal, 2012

the approved plan, including mandating minimum indicates that equity awards should be subject to minimum ve

vesting periods, prohibiting stock option repricing period (Glass Lewis 201Ia). Both ISS and GL measure equit

without shareholder approval and reducing the number using proprietary measures of the total plan dilution, which in

of shares available for grant under the plan. both outstanding equity awards and awards that can be grante

the plan (ISS 20 II a, Glass Lewis 20 11a). 

Amend Outstanding Amendments to previously awarded equity that are not Neither ISS nor GL consider stock options or restricted share

Equity Awards advantageous to the recipient, including extending time-based vesting to be performance-based. Both ISS and G

vesting periods, adding shareholding requirements and stock ownership guidelines and holding requirements as good 

adding performance conditions to the awards. compensation practices (ISS 2010, Glass Lewis 201Ia). 

81762.296

Appendix A. Compensation changes aligned with proxy advisor' voting policies (cont'd) 

Feature Description Rationale 

Eliminate "Poor" Amendment of existing agreements or the disclosure of Both ISS and GL oppose excise tax gross-ups and single trigg

Features From new agreements that eliminate excise tax gross-ups or agreements (ISS 2011 a, Glass Lewis 2011 a), 

Change in Control that eliminate single-trigger provisions (that provide 

Agreements payment to an executive without that executive having 

been involuntarily terminated), 

New Claw back Implementation ofa "Clawback" policy, which ISS examines whether a firm has a Clawback policy as part o

Arrangement provides for recoupment of compensation if it is Compensation Committee Communication & Effectiveness 

deemed to have been inappropriately earned (e.g., due evaluation. GL considers Claw back policies a "best practice" 

to restatement). Lewis 2011a) and highlighted the lack ofa Clawback policy 

significant number of their negative recommendations (Ertim

Ferri, and Oesch, 2013). 

Reduction or A reduction in or elimination of benefits or perquisites The value of executive benefits is captured in the computatioElimination of available only to senior executives(e.g., use of compensation for both ISS and GL. ISS provides detailed rev

Executive Benefits corporate aircraft, automobile payments, financial executive benefits in its Non-Perfonnance-Based Pay Elemen

planning, supplemental retirement plans and analysis (ISS 2011a). Both ISS and GL oppose the payment 

supplemental insurance plans). Also includes the due to executives for the receipt of benefits (ISS 2011a, GL 2

elimination of tax gross-up payments associated with 

executive benefits. 

Reduction in CEO A reduction to the CEO's salary or to the target bonus Both ISS and GL compare a firms CEO pay levels and firm 

Cash Compensation opportunity. performance to industry peers in order to determine the I pay/performance alignment under their proprietary analyses. 

poor performers, one way to align the pay with performance 

reduce the level of pay. 
334 


81762.297

Appendix B. Example disclosures of compensation changes 

aligned with proxy advisor' voting policies 

New performance-based equity plan: 

'"The final component o/the 2011 equity Dli/ords consists ofpeJ.formmlce units, (50%) of rile jJI!J/(mnance units wi/! 

vest on March 15, 20 J 3, and the remaining jijty percent (50%) "'Iii/vest on March 2014, subject to the prol'Ls'ions o/the 

Pe!/ormance Unit Award Agreement, The number ofpclformance units oHordeJ will be adjusted based on the achievement of 

ROA'OA (our A4iusied Operating Income divided by the sum of average Property, Plan! and I~quipment, average Goodwill and 

Other Intangible Assets, and average Operating Working CapftalJ- RONOA will he 1nf'(Jsuredjor fhe period beginning on 

January I, 201/, and ending on December 31. ]O! 2. Farge! ROtVOA is I (),O%," 

Source: Boise Inc. SEC Fonn 8-K, March 18,2011. 

New cash long-term inccntive plan: 

·'SUPERVALU INC (the "Company")finali:::eda long-term incentive programfor the FiscaI2012-201-i pelformance period 

pursuant to which participants, including the Company's named executive officers, will be eligible to receive incentive 

compensation based 011 the increase in the Company's market capitali::;ation during [he peljormance period, if any, using a fixed 

number of common shares outstanding 77w maximum amount a/increase in the ('ompUl?)' 's stock price is capped at 525, and the 

mw:imum percent (~flhe increase in market capitalization rhat will he paid to all participants will he -1.8% of such increase. The 

Company's top 800 employe(:"s 'will be eligible.f<)r a share 0/ the payments. if any. under the program. nle program provides/or 

a minimum, performance-based pa)'ollt opportunity equallO 25% of the target award value assuming $5.7 billion or more of 

EBIDTA is generated over the three-year performance period. Pa:rments under the program. if any ;.1li1l be made ha{(in cash and 

half in shares of the Company's stock following the end (~f tlte performance period The three-year measurement period aligns 

with the estimated time tofidly realize [he business tran~formation currently undent'a),' at the Cornpany." 

Source: Sl:PERVALl! I:'<C SEC Form 8-k, April 28. 2011. 

Restrict existing equil)' plan(s): 

"Termination a/Option Buyout Provisions in F,quity Plans, On January 28. 2011, {he Board o.fDirectors ofTl1e ProgreSSive 

Corporalion (the "Company'') approved the Third Amendment to The Progressive C01poration 20J{) Equity Incentive Plan ((he 

"Plan 'j and the 117ird Amendment to the Progressive Corporation 2003 Incentive Plan (together, the "Amendments, ,. copies of 

which are attached hereto as £"\hibits 10.1 and 10.2, res.pectiveZl'). Under each o,fthese plans, prior to the Amendments, the 

Company had the authority 10 buyout certain outstanding stock option awards (and. in the case of the 20 lO Equity Incentive 

Plan. stock appreciation rights). on terms and conditions acceptable 10 the CompensatIOn Committee o/the Hoard of Directors. 

In each case, the Amendments have modified the applicah/e plan to terminate the Company's authority to buyout such 

outstanding stock options and slack appreciation rights . .. 

Source: The Progressive Corporation, SEC Fonn 8-K, filed February 2. 20 I L 

Amend outstanding equity al\Jards: 

"On October 29, 2010, SYNIV'EX Corporation ('S}NNI:X''j amended the restricted stock unit award (the "RSUs ") [;ranfed to 

each a/Dennis Polk, SYNlI/EX' Chie/Op('rating OJ]icer. and Peter Larocque. ,,;YNNEX' President, U.S. Distribution (each, an 

"Qlflcer "). Subject (0 certain conditions, the RSUs will continue to vest in/ul! on the Jfjth anniversary of April 29,2010 (the 

"Original Grant Dare '). A portion o,(the RSUs will vest upon the.f<mrth andfl}ih anniversary of the Original Grant Dale 

providfd thai the qf(icer remains in continuous employment by S')~Vlv'EX through the vesting date. An additional portion o/the 

RSUr; will vest on the /ourJh andfijih anniversar}' of the Ori[;1nol Grant Date plYwided, that (i) the Officer remains in continuous 

employment by SYA?t/EX through the veslinR date and (ii){A) on the.fourth anniversary o,fthe Original Grant Date, SYNA'EX 

achieves on a cumulafive basis. 5% compound annual growth rate ("CACH") in eamings before income and faxes ("EBlr:; 

from continuing operations infiscal years ending .November 30, 2011lhrough 2013, and (B) on the fifth anniversary a/the 

Original Grant Date. SY,\WEX achieves on a cumulative basis, 5% CAGR in EBIT(rom continuing operations in fiscal years 

ending ,v'ovember 3(), :lOI I through 2014. In the event of an Officer's death prior to Ihe/ifih anniversary o/the Original Grant 

Date, SYA'NEX will tramfer to such Officer's f!sfate the number a/shares thai ,vollld have 'v'cstcd 011 an annual basis on or prior 

to such Officer's death The amendedform oj.'I{ock unit oRreement isflled herewith as Exhihit 10.1. ., 

Source: SYNNEX Corporation, SEC Form 8-K filed November 4, 2010. 
335 


81762.298

Appendix B. Example disclosures of compensation changes 

aligned with proxy advisor' voting policies (conrd) 

Eliminate "poor" features from change in control agreements: 

"The existing employment agreemrnts were amended and restaled to: 

e:rtend the term of the agreemenfs/or one year, to june 22,2014 in the case o//vlr. Bordelon and 10.l1111e 22,2013 in 

the cm;e 0/ the Exeeulive Vice Presidents; 

rf'l11ove the prior provisions that permitted the agrf'ements to he automatically extended/o/' an additionai year on the 

annual anniversmy date Q,( the agreement unless either par(v (0 the agreement has given notice that the term will not be 

extended (common/:v referred to as an "evergreen" provision); and 

revise the provision in Mr. Bordelon's agrfemem with the Company "which requires the CompmlJ' to (I) reimburse Afr 

Bordelon for anr 20% excise tax incurred under Section 280(; of the Internal Re\'enue Code of 1986, as amended 

("Section' 280d"), upon severance of employment «fter a "chm;ge-in-control ", as defined under Se(:rion 280G. and (2) 

pay the additional federal, state and local income faxes and excise taxes 011 such reimhursement in order /0 place Mr. 

Bordelon in the same ajler-fax position he would have been jn If the excise tax had not been imposed (commonly 

referred to as a "Seclion 280G gross-up" provision) slich Ihat lire Company will he obligated to pay a Section 280G 

gross-up to Afr, Bordelon 011/..1/ with respect to a change-in-control which occurs on or hejore June 22, 20N. 

The determination (0 remove the evergreen provisions in the agreements and. in the case oJMr. Bordeloll's agreement 'with the 

Company, limit the provision providingJor a 280G gross-up pa.vmenl to change-In-control tral1sactions occurring on or befhre 

June 22, 20/4, 'were undertaken primari(v upon consideration a/the governance risk indicators ("GRId") published by 

RiskMelrh:s Group (formerly known as Institutional Shareholder ,')'ervices or "IS'5'/ Ihe Compan.v has taken olher actions 

related to its GRid score, includinK the adoption (~( chief executivp (4Jicer and director stock ownrrship guidelines and of a 

compensation clawback policy, " 

Source: Horne Bancorp, Inc., SEC Form 8-K filed March 30, 2011. 

New clawhack arrangement: 

"On March 18, 2011, the Board o/Chelsea adopted a recoupment po/ie)' that reqUires all execUfive officers to repay or return 

cash bonuses and/or equity awards in the event: (U the Company issues a material restatement oJitsjinancial statements and 

where the restatement was caused by the employee's intentional misconduct: (ii) the executive officer was found 10 be in violation 

oInon-compete provisions 0/ any plan or agreemel1l; or (iii) the executive (?f{icer has committed ethical or criminal violations. " 

Source: Chelsea Tnerapcutics IntemationaL Ltd .. SEC Fonn 8-K filed March 18,2011. 

Reduction or elimination of executive benefits: 

"On December 1, 20/0, Mueller Water Products, Inc. (the "Company') and Gregory E lIyland, the Company's Chairman 0./ the 

Board (~lDirectors, President and Chief Executive Officer, entered into an amendment (the "Amendment ") (0 Mr. Hy/and's 

emploJ-'lnent agreement (the "Agreement"j. 117e Amendment deletes a provision from the original Agreement that entitled Afr. 

I{vland to reimhursement/or membership dues in one counlt:}' club and one luncheon club in the A1Imllo, Georgia area. fhe 

Amendmellf is consistent 'with a recent determination by the Company's Compensation and Human Resources Committee to 

modify the Company's policy/or executive cluh reimbursement, such that the Company will no longer reimburse e,r.ecu!ives/or 

club membership fees ' 

Source: Mueller Water Products, Inc .. SEC Foml 8~K. filed Decenber 6, 2010. 

Reduction in CEO cash compensatiol1: 

"On February 3, 20 I 1, Jofluwing the recommendation of the Compensation Committee of the Board 0/ Directors (the "Board'; 

o.f Intuitive Surgical, Inc, ("Intuitive" or the "Company"), the Board approved a decrease 0.(5100,000 in the base salmyror 

Lonnie Smith. the Company's executive officer as well as [he Chairman a/the Board. Mr. Smith's new hase salary. ejjeclive 

JanuOl:V I, 201 I, 'will be SIOO,OOO and he will not participate in the Company's bonus plan. " 

Source: intuitive Surgical, Inc .. SEC Fonn 8~K filed February 3, 201 L 
336 


81762.299

Figure 1. Uistribution of shareholder meeting dates 

Figure I presents the distribution of annual shareholder meetings in a window around January 21" (day 0) in both 

2010 and 20 II. Sayan pay is required under Dodd-Frank at annual meetings on or after January 21 ",2011. The 

vertical axis indicates the number of companies that had the annual meeting that day. The horizontal axis indicates 

the number of days before or after January 21 ". For example "-4" means 4 days before January 21" and "4" means 

4 days after January 21 ". The darker bars refer to meetings in 20 I 0 and the lighter bars to meetings in 2011. 

16 

14 

12 

# annual 10 

meetings 8 

6 

4 

2 

0 

-7 -6 -s -4 -3 -2 -1 0 2 

# days trom/to 1121 (day 0) 

4 7 

1112010 

02011 
337 


81762.300

Table 1. Descriptive statistics for tbe sample firms 

This table reports selected descriptive statistics for our sample ofl,008 firms and the 4,513 benchmark firms in the 

Compustat-CRSP universe with fiscal year end date between 613012010 and 3/31/20 II. Panel A presents descriptive 

statistics of variables related to firm characteristics, Si=e is the firm' 5 equity market value (in millions of dollars), 

/3,11 is the Book-to-market ratio, Leverage is total liabilities divided by total assets. Volatility is the annualized return 

volatility, computed as the standard deviation of daily returns over 365 days prior to fiscal year end. ROA is return 

on assets (operating income scaled by total assets). Pctinstit is the percentage of the finn's shares owned by 

institutions. Panel B presents the industry distribution of the sample and Compustat finns using Fama and French 

industry classification. 

Panel A, Descriptive Statistics 

Firm characteristic 

Afarket Cap (millions) 

8M 

Leverage 

ROA 

Volatility 

Petinsti! 

Panel B. Industry Sectors 

mean 

5,982 

0.57 

0.22 

0.06 

0.40 

0.72 

Chemicals and allied products 

Consumer durables 

median 

I, 173 

0.51 

0.17 

0.07 

0.37 

0,78 

Oil, gas, and coal extraction and products 

Healthcare, medical equipment and drugs 

Manufacturing 

Financial firms 

Consumer nondurables 

Other 

Wholesale, retail, and some services 

and television transmission 

3,750 499 

1.09 0.60 

0.20 0,14 

0.07 0,05 

0.48 0.42 

0,51 0.55 

2,19% 2.34% 

2,02% 2.09% 

5,14% 5,13% 

10.86% ]0.41% 

8,62% 10.46% 

22.71% 23.66% 

4.30% 4,13% 

13,34% 12.20% 

7.73% 8,67% 

3.08% 3.14% 
338 


81762.301

Table 2. Descriptive statistics for measures used in the analyses 

This table reports descriptive statistics for the measures used in subsequent analyses for our 2,008 sample firms. 

ic")'S_ against equals one if ISS recommended against and zero otherwise. GJ,_against equals one if Glass Lewis 

recommended against and zero otherwise, P4P is a pay-for-performance indicator variable that equals one (and zero 

otherwise) if: (i) the CEO's compensation increases from 2009 to 2010, (ii) total shareholders' returns in the last 

year (7~)RI Y) is lower than the median TSRI Yamong the companies in the same GICS code, (iii) total shareholders' 

returns in the last three years (JSR3 Y) is lower than the median TSR3 Y among the companies in the same GlCS 

code, and (iv) the CEO's total compensation is above the median compensation of the peer companies (the peer 

group is defined fonowing ISS's criteria). PayDisparity is the ratio between CEO compensation and the average 

compensation of the other named executive officers (NEO's). PCILTincentives is the present value oflong-term 

incentives divided by the slim of the present value of both long term and short term incentives. PctPBincentil'cs is 

the present value ofperfonnance-based equity incentives divided by the sum of the present value of both 

performance-based and non-performance-based equity incentives. nP,H is the number of ditTerent performance 

measures used by the LTIP's, stock and option grants to the CEO. GRID camp equals one if the compensation 

GRId score computed by ISS is labeled as !thigh concern", two ifit is labeled as "·medium concern" and three if it is 

labeled as "low concern". WithholdRec is the number of "withhold" or negative recommendations issued by ISS on 

directors of the company in the previous proxy season. PctSupport is the percentage of favorable advisory votes on 

SOP. Fail equals one if the SOP proposal failed to obtain majority support and zero otherwise. ISSlnl11lence is 

calculated as the sum across funds in that company of the probability of voting with ISS conditional on 

disagreement multiplied by the holdings of each fund in the company. 

Panel A. Variables used in subsequent analyses 

25iJi pct mean median 75')' pet 

SOP voting recommendations 

ISS. ,against 0 0.13 0 0 

CN", _against 0 0.21 0 0 

Proxy advisors' SOP policies 

P4P 0 0.13 0 0 

jJaydisparity 1.88 2.76 2.51 3.35 

Pctl,,7'incentives 0.51 0.62 0.73 0.83 

PctPBincentives 0.32 0 0.71 

nPM 2.39 2 4 

Other l'ariahles 

GRIDJomp 2 1.97 2 2 

WithholdRec 0 0.13 0 0.08 

Voting outcomes 

Pctsupporl 0.87 0.90 0.95 0.98 

Fail 0 0.016 0 0 

Measure of ISS injluence 

~/§§~fluenc.,,-C~nJj_) _____ 5_'l! __ . ___ !:.~ __ 8_'<l.Q._~.J.l:~ 

Panel B. ISS and GL recommendations 

_°110'1:":>'__ ~()-"-Ix.0:.__ ISS and GL 

ISS recommendation For Against For Against 
339 


81762.302

Table 3. Proxy advisors' SOP Recommendations 

This table reports results of probit regressions testing the determinants of ISS SOP recommendations. Panel A and 

panel B analyze the determinants for ISS and Glass Lewis recommendations, respectively. 1'41' is a pay-forperformance indicator variable that equals one (and zero otherwise) if:(i) the CEO's compensation increases from 

2009 to 20 I 0,( ii) total shareholders' returns in the last year (TSRI J) is lower than the median lSRI Y among the 

companies in the same GICS code, (iii) total shareholders' returns in the last three years (TSR3 n is lower than the 

median TSR3Yamong the companies in the same GICS code, and (iv) the CEO's total compensation is above the 

median compensation of the peer companies (the peer group is defined following ISS's criteria). 1'ayDisparity is the 

ratio between CEO compensation and the average compensation for the other named executive otlicers (NEOs). 

PctLTincentives is the present value of long-term incentives divided by the sum of the present value of both long 

term and short term incentives. PctPBincentives is the present value of performance-based equity incentives divided 

by the sum of the present value of both performance-based and non-performance-based equity incentives. nPMis 

the number of different performance measures used by the L TIP's, stock and option grants to the CEO. 

GRID _comp equals one if the compensation GRid score computed by ISS is labeled as "high concern", two ifit is 

labeled as "medium concern" and three ifit is labeled as "low concern". lVilhholdRec is the number of "withhold" 

or negative recommendations issued by JSS on directors of the company in the previous proxy season. *, **, and 

*** denote significance at the 10,5 and 1% significance level (two-tail). 

Panel A. ISS recommendations 

1'41' 

1'ayDi.lparily 

PctLTincentives 

PctPBincenties 

nPM 

GRiD_comp 

Pseudo 

Panel B. GL recommendations 

P4P 

PayDi'l>arily 

pctLTincentives 

pctPlJincenties 

nPM 

GRIDcomp 

IFithholdRec 

Pseudo R2 

N 

1.30*** 

+ 

0.71 *** 

+ 

-32.14 

14.71 

13.87% 

3.30% 

1,849 

coer I-stat 

-1.04*** -6.51 

1.30*** 14.04 

0.13 *** 5.08 

0.04 0.29 

-0.03 -0.35 

-0.06*** -2.72 

-0.35*** -5,40 

20.75% 

0.58*** 6.37 

0.17**' 6.94 

0.61 *** 4.64 

-0.04 -0.41 

-0.01 -0,49 

-0.19*** -3.20 

0.15 1.15 

8.52% 

1,849 

81762.303

Table 4. Proxy advisors' SOP Recommendations and Voting Outcomes 

This table reports results ofthe association between voting outcomes ISS SOP recommendations and ISS recommendations. Panel A presents results 

cross-sectional determinants of voting suPPOtt. PctSupport is the percentage of favorable advisory votes on SOP. ISS_ii1f/uence is calculated as the su

funds in that company of the probability of voting with ISS conditional on disagreement multiplied by the holdings of each fund in the company. Pctl

percentage of shares owned by institutions. IS8_ against equals one if ISS recommended against the company's compensation practices and zero other

Panel B compares the influence of recommendations by ISS and GL on voting support. ',", and **' denote significance at the 10, 5 and 1 % signific

(two-tail). 

Panel A. Influence of ISS on voting support 

Dep. Val': PctSupport 

Variable coef 

Conslant 0.93*** 

ISS_against ISSiI?f/lIencc ISS_against'ISS)njIlience 

PctInstit 

r8S against'Pctinstii 

Pseudo Rl 

l\' 

-0.25'" 

Panel B. Influence of GL on voting support 

Dep. Val': PCISupport 

Variable 

Constant 

GLagainst 

IS,)_ against 

Petinstit 

GL_against'PctInstit 

Pseudo R2 

,v 

(1) 

t-slat 

568.18 

-25.68 

49.21% 

2,008 

coef 

0.96'" 

-0.25'" 

-0.002**' 

(1) 

coef I-stat 

0.94'*' 460.74 

-0.18'*' -22.88 

35.66% 

1,849 

(2) 

I-stat 

267.28 

-26.63 

-7.19 

50.66% 

2,008 

coef 

0.96*" 

-0.13'" 

-0.21'" 

(3) (4) 

coef t-stat coef I

0.95'" 300.96 0.96*" 19

-0.15'" -9.07 -0.08'" -2

-0.001'" -3.98 

-0.01*" -6.67 

-0.04'" -5

-0.24"* -6

53.16% 53.7

2,008 2

(2) (3) 

I-stat coef I-stat 

771.07 0.94*" 160.67 

-24.34 -0.10'*' -3.65 

-24.62 

-0.01 -1.42 

-0.09" -2.55 

69.16% 36.32% 

1,849 1,849 

81762.304

Table 5. Characterization of compensation changes preceding the annual meeting 

Panel A presents descriptive statistics of selected characteristics of firms making compensation changes within the eight-month window previous to the fi

the proxy statement prior to the 20 II annual meeting. The first two columns of Panel A present descriptive statistics of firms that filed 8-Ks announcing 

compensation changes that conform to ISS's policies. The second set of columns of Panel A present descriptive statistics of the remaining sample firms. 

third set of columns of Panel A present descriptive statistics of firms that filed 8-Ks announcing compensation changes that are unrelated to ISS's policies

Compensation changes that conform with ISS policies are the following (see Appendix A): Amendment to outstanding awards, reduction of burn rate, new 

LTIP, reduction in cash comp, changes/amendments to change of control plans, new performance-based equity plan and reduction in benefits. P4P is a p

performance indicator variable that equals one (and zero otherwise) if: (i) the CEO's compensation increases from 2009 to 2010, (ii) total shareholders' re

the last year (TSRI Y) is lower than the median TSRI Yamong the companies in the same GICS code, (iii) total shareholders' returns in the last three years 

(TSR3 Y) is lower than the median TSR3 Y among the companies in the same GICS code, and (iv) the CEO's total compensation is below the median compe

of the peer companies (the peer group is defined following ISS's criteria). ISS_ilifluence is calculated for each company as the average probability of each 

voting with ISS conditional on disagreement multiplied by the holdings of each fund in the company. PctInstit is the percentage of shares owned by instit

Panel B presents similar statistics using a random sample of compensation-related 8-Ks filed within the eight-month window previous to the filing of the p

statement corresponding to the 2006 - 2010 annual meetings. *, **, and *** denote significance at the 10,5 and 1% significance level (two-tail). 

Panel A. 2011 annual meeting (the initial SOP vote) 

Firms with P A Remainder of Firms with other 

aligned 8-Ks sample firms compensation 8-Ks DijJ. (1)-(2) DijJ. (1

(1) (2) (3) p-values p-va

Mean Median Mean Median Mean Median t-test Wilcx t-test 

P4P 0.18 0.00 0.13 0.00 0.11 0.00 0.067 0.067 0.015 

ISS_influence 9.34 8.74 8.77 8.27 9.09 8.76 0.090 0.043 0.496 

PctInstit 0.77 0.81 0.71 0.77 0.72 0.77 0.000 0.001 0.004 

Number a/firms 275 1,733 377 

Number of changes 297 436 

81762.305

Table 5. Characterization of compensation changes preceding the annual meeting (c

Panel B. 2006-2010 annual meetings (before the requirement of a SOP vote) 

Firms with P A Firms with other 

aligned 8-Ks compensation 8-Ks Diff. (1)-

(1) (2) p-value

Mean Median Mean Median t-test W

P4P 0.07 0.00 0.06 0.00 0.539 0

ISS_influence 10.03 9.72 9.79 9.25 0.548 0

PctInstit 0.80 0.84 0.80 0.83 0.530 0

Number of firms 188 450 Number of changes 201 532 
343 


81762.306

Table 6. Compensation changes and proxy advisors' SOP recommendations 

This table presents results of probit regressions testing the association between ISS recommendations and changes in 

compensation previous to the proxy season. The dependent variable IS'S' ~ against equals onc if ISS recommended a 

vote against the company's compensation practices and zero otherwise. The first set of columns includes all sample 

firms. The second set of columns includes 8-Ks filed during the 8 months previous to the proxy statement of the 

2011 proxy season. Sum J'A _Aligned is the sum of PAAligned across all of the 8-Ks for each firm in the 8 months 

prior to the proxy statement of the 2011 proxy season. Proxy advisor aligned compensation changes arc the 

following (see Appendix A): Amendment to outstanding awards. reduction of bum rate, new cash LTlP, reduction in 

cash camp, changes/amendments to change of control plans, new performance~based equity plan and reduction in 

benefits. PA Aligned is the number of Proxy advisor aligned compensation changes announced in each 8-K. P4P is 

a pay-for-pc;fom~ance indicator variable that equals one (and zero otherwise) if: (i) the CEO's compensation 

increases from 2009 to 2010, (ii) total shareholders' returns in (he last year (TSRI)) is lower than the median TSRI r among the companies in the same GICS code, (iii) total shareholders' returns in the last three years (TSR31~ is 

lower than the median 1'SR3 r among the companies in the same GICS code, and (iv) the CEO's total compensation 

is below the median compensation of the peer companies (the peer group is defined following ISS's criteria). * ** 

and *** denote significance at the 10,5 and 1% significance level (two-tail). 

Dep. Var: ISS_against All sample firms 

LnEi!p.!":G!.i(lbles. coer t-stat 

Constant 1.38*" -30.56 -1.24*** --15.52 

Sum_PA_Aligned -0.16* -1.73 

PA_Aligned -0.22' -1.94 

P4P 1.31*** 14.77 1.03*** 7.07 

Pseudo R2 14.07% 8.73% 

N 2,008 733 

81762.307

Table 7. Market reaction to compensation changes preceding SOP 

This table analyzes cross-sectional differences in the market reaction to compensation-related 8-Ks filed during the eight months prior to the proxy st

release date. The dependent variable, AdjRet, is the average daily risk-adjusted return on the day of the 8-K fIling, estimated using the Fama and Fren

factor model plus momentum. AdjRet is expressed as a %. Column (I) includes 8-Ks filed during the 8 months preceding the proxy statement filing 

fiscal year 2011. Column (2) includes a random sample of 8-Ks Ii'om previous (2006-2010) fiscal years. FA_Aligned is the number oflSS-lriendly 

compensation changes announced in the 8-K. ISS-friendly compensation changes are the following (see Appendix A): Amendmenl to outslanding aw

reduction of burn rale, new cash L TIP, reduction in cash comp, changes/amendments to change of control plans, new performance-based equity plan 

reduction in benefits. Panel 13 compares A'URet on the 8-K filing day to the average AdjRet on the 30 days preceding the 8-K fding date and the 30 d

following the 8-k filing date. The {-stals are in parenthesis. *, **, and .** denote significance at the 10,5 and I % significance level (two-tail). 

Panel A. Market reaction and comparison to previous proxy seasons 

Dependent variable: AdjRet 

Variable 

Constant 

FA_Aligned 

N 

R' 

2011 2006-2010 Difference 

proxy season proxy seasons in coefficients 

(1) (2) (1)-(2) 

0.096 0.162 -0.065 

(0.86) (1.21) (-0.89) 

-0.444'" 0.043 -0.488-

(-2.91) (0.21) (-191) 

733 733 

1.15% 0.01% 

Panel B. Comparison to market reaction on other days around the 8-K filing date 

AdjRel on days AdjRet on days 

preceding the 8-k AdjRet on 8-k following the 8-k 

filing date filing dale filing date Difference 

(days -30 to -1) (doy 0) (days 1 to 30) in AdjRet 

el) (2) (3) (l)-{2J 

8-Ks aligned with FA policies 0.011 -0.345*-* 0.019 0.356**-

(N=297) (0.41) (-2.14) (0.81) (2.85) 

Other compensation 8-Ks 0.037 0.059 -0.001 -0.022 

(N-.J36) (1.51) (0.58) (-0.02) (-0.19) 

D

-0
345 


81762.308

UNITED STATES HOUSE OF REPRESENT A TIVES 

COMMITTEE ON FINANCIAL SERVICES 

Hearing of the 

Subcommittee on Capital Markets and Government Sponsored 

Enterprises 

On 

Examining the Market Power and Impact of Proxy Advisory Firms 

June 5, 2013 

Testimony of Lynn Turner 
346 


81762.309

I would like to thank Chairman Garret and Ranking member Maloney, and members of the 

Committee for the opportunity to testify today. 

I am Lynn Turner and I work as a managing director at the economic and forensic consulting 

finn LitiNomics. My comments draw upon my past experience as a member ofthe board of 

directors of public companies; as a member of the board of two institutional investors, one a 

mutual fund and the other a public pension fund; as a member of managemcnt and financial 

executive; as a former regulator with the Securities and Exchange Commission (SEC) where I 

served as Chief Accountant; as a member of management of a scmiconductor company and also 

a senior executive and head of research of Glass Lewis during its initial four years. I 

My experience has given me a broad and balanced perspective of proxy voting, and a well 

informed insight into the process. In the past, as a corporate board member, I have been the 

subject of proxy voting recommendations. As Vice President and head of research at Glass 

Lewis, I have participated in and overseen the process with respect to the preparation of proxy 

voting recommendations provided to investors and asset managers. And as a board member of 

two institutional investors which voted proxies, I have been involved with establishment of 

proxy voting guidelines and the proxy voting process. 2 Currently, I am a governor appointee to 

the board of the Public Employees Retirement Association of Colorado (Colorado PERA), a 

pension fund that manages the investments for hundreds of thousands of Coloradoans. I chair 

the shareholder responsibility committee of the fund which oversees the proxy voting by the 

fund. However, the comments I express today are my own views and not necessarily those of 

the PERA board, which takes formal positions only after public discussion and votes. 

Proxy Voting 

Proxy voting is an important right that the owners of public companies hold. These owners -

investors - rely on the management teams to run the day to day operations of these companies 

and set their strategic and tactical plans. They also depend on members of the board of directors 

1 I have not had any financial or other interest in Glass Lewis since I left over 6 years ago. 

2 At the mutual fund, a "fund of funds complex, we utili7.ed Institutional Shareholder Services for voting 

recommendations. At Colorado rERA the fund uses research principally from Glass Lewis but also uses 

Institutional Shareholder Services. 
347 


81762.310

to exercise reasonable oversight of management including among many items, their performance 

and ability to achieve expected results, compensation, and business investment decisions. 

Proxy voting provides investors, and/or the asset managers managing their money, with a useful 

market based mechanism with which to establish the accountability of both the board of directors 

and management It permits investors as owners of the company, to weigh in on important 

matters and to express their approval, or disapproval, of the performance of those on the board 

who serve as their elected representatives, just as members of Congress served those who elect 

them. 

My experience has demonstrated that many, but perhaps not all, investors take this responsibility 

very seriously. J believe that if you examine the web sites of the largest public pension funds 

you will find almost all have their own custom proxy voting guidelines. Similarly, if you look at 

the websites of the 15 largest money managers such as Fidelity, Vanguard, and Blackrock, you 

will find they also have their own custom designed proxy voting guidelines, as well as staff 

dedicated to proxy voting. 

Upon reading the proxy voting guidelines of some of these asset managers, it appears that they 

have adopted policies that are similar to those of the two proxy advisory firms, Institutional 

Shareholder Services (ISS) or Glass Lewis (GL) on some issues. However, I believe this is most 

often the result of many in the investment community having similar views on what is "good 

governance." That is also why on proxy voting issues such as staggered boards, majority voting, 

pay for perf0n11anCe or poison pills, you will see investors at specific companies vote in 

agreement In doing so, they may well vote in the same manner as ISS or GL have 

recommended. It is likely in such proxy contests, the asset managers would have voted similarly 

even if there had not been an ISS or GL recommendation. 

My experience has informed me that the larger asset managers, such as Fidelity, Barc1ays or 

Black Rock, along with the large public pensions, are likely to follow their own voting 

guidelines and determinations, rather than those of ISS or GL. While they may buy research 

from the proxy voting services to gather useful infonnation and assist with their analysis of the 

2 
348 


81762.311

issues, it is not uncommon they will vote differently than ISS or GL recommends, and often vote 

with management, And buying of such research, to add to one's available information about an 

issue, certainly should not be criticized in the context of trying to be fully informed about an 

issue. Interestingly, it is these large asset managers who also typically hold the largest 

percentage of institutional investment in public companies. I believe my experience is very 

consistent with useful data the Council of Institutional Investors (CIl) has also provided the 

Subcommittee. 

Proxy Voting in the Global Market Place 

In today's global markets, an asset manager may invest in dozens of capital markets, and in 

thousands of public companies. for example, at Colorado PERA, the fund makes and manages 

investments on a global basis in 7,000 to 8,000 companies. The proxies for these companies 

may involve the election of numerous directors, approval of compensation and acquisitions, 

shareholder initiatives submitted for shareholder approval, and any number of additional matters. 

Proxies in non U.S. markets are often the subject of different proxy laws and requirements 

requiring knowledge of each jurisdiction, if one is to vote responsibly. Some foreign countries 

have a very short period oftime between when shareholders are informed of the matters subject 

to shareholder vote, and when the proxy votes must be completed. 

Many mutual or pension funds do not have unlimited staff who can read thousands of proxies 

and then research and submit an informed vote on the issues as required. My experience tells me 

that it would take well over a hundred staff, at a very significant cost to vote 8,000 proxies in a 

global market place. That would be a cost that would have to be passed on to investors, 

significantly increasing their fees, and reducing their investment returns, and ultimately, the 

amounts they are trying to save for retirement. 

Instead, the funds rely, in part, on research they can buy from ISS and/or GL or others, along 

with their own research and proxy voting guidelines, to make a decision on how to vote. From 

one perspective, this is not that much different from a board of directors who must rely on 

3 
349 


81762.312

management and staff of a company to keep up to date and informed about the business and in 

their conduct of board votes. 

Transparency in Proxy Voting 

There is a significant amount oftransparcncy today when it comes to proxy voting. For 

example, both ISS and GL post their proxy voting guidelines for all to see on their public wcb 

sites. J Most large pension and mutual funds also post their proxy voting guidelincs.4 

At Colorado PERA, the Shareholder Responsibility Committee reviews the proxy voting 

guidelines, in a public meeting, on an annual basis. The committee also reviews and analyzes 

the voting record of the fund on key and significant issues. Proxy votes that engender a lot of 

attention are also reviewed. At times, the PERA staff also contact me in advance of select votes 

to discuss those votes, which are subsequently also discussed in a public board meeting. At thc 

mutual fund I served on the board of, we had a similar process with the exception that our board 

meetings were not public. 

Much to their credit, ISS goes through a very rohust public comment process each year in which 

their guidelines are posted for public comment. Comment letters reccived by ISS are also made 

public. ISS makes the updates and changcs to their policies publicly available on their websitc 

as well. They also conduct significant outreach to various parties. I suspect that from beginning 

to end, their process is as transparent as, or more so than federal agencies may undertake with 

respect to rule making. 

J See GL proxy voting guidelines at: http://www.glasslcwis.com/issuer/guidelines/ 

ISS proxy voting guidelines are also available at 

http://www.issgovernance.com/policyI2013/policyjnformation 

4 See Colorado PERA Proxy Voting Policy at: 

https:llwww.copera.org/board/shareholdercommittee/Proxy V otingPol icv.pd f 

4 
350 


81762.313

GL each year undertakes significant outreach to those investors who arc their clients. They seek 

and receivc from such clients their views on proxy voting issues. GL also interact with public 

companies receiving fcedback. 

However, it is important that the voters .- investors who own the companies determine their 

voting guidelines and how they will vote. It should not be up to non investors, to decide how the 

investors will vote on a particular issuc. While it is more than fair to permit management to give 

their perspective on an issue, which they can do in the proxy statement they control, it would be 

highly improper for them to establish the rules with respect to how an investor will vote on a 

particular issue. 

For example, I have heard some express a view that ISS or GL should have to submit drafts of 

their proxy voting recommendations to management before they can issue a final report. I find 

such a notion absurd, as in and of itself, it creates an inherent conflict with management 

permitted to edit a report on recommendations that affect them directly. It is akin to requiring 

teachers to submit report cards to students for editing before they can be sent home. While this 

is something we all might have liked at one point in time or another, I don't believe it is 

something that would improve the quality of grading. 

However, as I discuss further below, I believe transparency in voting can and should be 

improved. Currently, mutual funds disclose once a year how they voted on proxies during the 

course of the year. By the time they disclose the vote, it is old news and history for the investors 

who have given them the money they manage. Investors deserve more timely information. 

At Colorado PERA, we disclose our votes within 30 days. Other pension funds disclose their 

votes quicker. I believe more timely disclosure of votes by asset managers to investors should be 

required as I discuss below. 

Does One Size Fit All? 

5 
351 


81762.314

An issue I hear from time to time is that the proxy voting guidelines of GL, ISS or for that 

matter, mutual or pension funds are akin to a "eheck the box" approach to corporate governance 

and too rigid. Companies argue they should be tailored to each company. Given there are 8,000 

to 10,000 public companies in the United States alone, that would take a lot of "tailoring." 

The practical reality today is that there is a fair degree of consensus around many, but not all, 

governance issues. For example, over the years, many of the large US public companies have 

agreed to accept a majority voting standard for directors. As a result, many proxy voting 

guidelines endorse such a governance measure. Likewise, many investors oppose the creation of 

poison pills or staggered boards that may hamper, rather than enhance shareholder value. As a 

result, these views, onee viewed as "way out there" are now often contained in proxy voting 

guidelines. As a result, while such positions may be in the policy guidelines of ISS and GL they 

are also likely to be in the custom guidelines ofmany other pension or mutual funds, 

At the same time, pension and mutual funds do not view their proxy voting guidelines as rigid 

documents that must be followed on every vote. On occasion, at both the mutual and pension 

funds whose boards I have served on, I have received calls from our staff in which it was 

explained to me a waiver of our guidelines would be appropriate. The PERA guidelines in fact 

note that some issues will be voted on a case by case approach considering the fiduciary 

obligation the fund has to those whose money it manages. And while I was at GL, it was not 

uncommon at all that our clients would vote in a manner inconsistent with the GL guidelines. To 

say that GL dictates to their clients how they must vote couldn't be further from the truth, a 

stretch of one's imagination, 

Myth Busters 

There are a couple of "Myths" with respect to proxy voting I would like to address. The first one 

is that ISS, GL or the pension funds are somehow "biased" against management and vote 

according to how the labor organizations would like them to vote. 

6 
352 


81762.315

[n my opinion, if there is a bias, it is towards management. For example, Colorado PERi\. voted 

on 37,365 management proposals in 2012. PERA voted with management or against the 

shareholder on 32,039 of those proposals or 85.75 percent of the time. On 1,545 shareholder 

governance proposals. PERA voted with management on 924 of the proposals or 59.81 percent 

of the time as opposed to just 40.19 percent of the time with shareholders. I believe the Council 

of Institutional Investors and the Florida State Board of Administration have also provided the 

Subcommittee with evidence of a bias towards voting with management on issues. 

Another indication of this bias towards management is in voting recommendations by ISS. 

According to ISS, to date in 2013, ISS has recommended a vote for directors of Russell 3000 

companies 92.8 percent of the time as opposed to a withhold or against recommendation just 7.2 

percent of the time. During the 2012 calendar year, ISS recommended for 91.3 percent of the 

nominees at Russell 3000 companies as opposed to a vote against or for withhold just 8.7 percent 

of the time. Given half of the companies in the market are underperforming the market and half 

are outperforming. votes for over 90 percent of the directors can hardly be construed as a bias 

against management and the directors. It is also worth noting that even when directors fail to 

garner a majority of support from the shareholders, they seldom resign, choosing instead to 

ignore the vote. 

With respect to GL voting, to date in 2013, they have recommended a "withhold" vote against 

19,952 directors or just 9.95 percent of the time. In 2012, in the election of26,366 directors, 

they recommended a withhold vote 12.85 percent of the time, a similar percentage to their vote 

in 2011. 01'65 directors who failed to gain 50 percent of the support from their investors in 

2012, GL recommended for 8 of those directors. Of2011 dircetors who failed to get a majority 

support in 2011, GL had recommended a vote for 22 of those directors. Once again, the facts do 

show a bias toward management and existing directors. 

The reality is that there arc around 100 or fewer proxy voting contests each year that garner the 

attention of the press and media. These typically are the result of a significant event at a 

company including poor stock performance, large amounts of compensation coupled with poor 

7 
353 


81762.316

company pcrformance, a financial debacle of some sort, or a failure of the board and 

managemcnt to adequately cxplain actions they have taken such as with respect to acquisitions. 

A recent example of this was the proxy contest at Hewlett Packard. This company had total 

shareholder returns of a negative 22.5 percent over the recent five year period. During this 

period the company's market capitalization (value) had droppcd precipitously. Management had 

to write off as worthless over $19 billion they had paid out for acquisitions during that period. 

They had also gone through a number of CEOs and had experienced turmoil and turnover on the 

board. It is no wonder then that investors did express concern about the returns they were 

receiving on their investments, and the management and board of trustees who were stewarding 

the company. It was clearly not just labor funds who were involved with this contested proxy 

vote. 

Another such example is thc rccent contested election of a director and chairman of the board at 

Occidcntal Petroleum Company (OXY). Oxy had a total shareholder return of just 1.89 percent 

over the previous five years. The company surprised the market by announcing they were 

seeking a new CEO, in a move viewed by some as drivcn by the fonner CEO who had become 

chairman of the board. The recently retired CEO had been one of the most highly compensated 

CEO's in America. This resulted in shareholders casting ..... their shares against bim by more 

than a 3-to-1 margin.,,5 Clearly many investors werc involved with this outcome, which was not 

driven by labor funds. 

Another myth is that research reports from ISS and GL are inaccurate and contain many errors in 

data. Certainly, with up to 40,000 proxies being voted around the globe, and each of those 

proxies having a multiple of votes, some errors, while not desired, are inevitable given the 

process involves humans. 

When errors do occur, there are mechanisms for addressing the issue. For example, on their 

website, GL has a web page for issuers. On this web page issuers can contact GL directly and 

5 Dailey Finance at: http://www.dailyfinance.com/20 13/0SI06/ray-irani-oustcd-chairman-occidenlal-pelroJeuml 

8 
354 


81762.317

make them aware of any errors. 6 It has been my experience, that when proxy advisors are made 

aware of errors, they respond in a responsible fashion, correct their rcports, and republish them 

with the corrected infonnation. 

However, when J was head of research at GL, it was not uncommon that I would take a call and 

have a discussion with a company official regarding the "facts" in a report. Howcvcr, the facts at 

times turned out to be corrcct, and it was rcally the rccommendation that the official had a 

problem with. At other times a fact was wrong and needed to be corrected bccause the 

disclosures in the proxy were not clear. Since proxy advisors do rely extensively on the public 

disclosurcs in proxy statements, the quality and accuracy of thcir research can be limited by the 

quality of the proxy disclosures. 

My cxperience using both GL and ISS reports are that they are typically correct, and provide a 

reasonable basis for the recommcndation provided. 

Recommendations 

As a former executive, J have found that one should always look for continuous improvement. 

believe proxy voting is no different in that regards. and therc are things that can be done to 

improve our proxy voting system. They include: 

I. Improving transparency. I believe that proxy voting, and the votes actually made by asset 

managers should bc transparent to the peoplc whose money they manage on a timely 

basis, just as is donc with political elections. Once a year, mutual funds do disclose their 

votes, often long after they have been cast and the elections are over. Instead. I believe 

asset managers should be required to disclose their votcs to those who money they are 

managing at the time they actually vote. 

2. Removing conflicts of interest. I strongly belicve that onc is very conflicted when they 

consult on how to establish or improve corporate governance or compcnsation plans, and 

then turn around and issue a recommendation on whether or not what the company has 

" See GL website: http://www.glasslewis.com/issucr/ 

9 
355 


81762.318

done is acceptable. This is all too similar to having an auditor do the book keeping for a 

public company, and then opine on whcther the books arc done right or not. Congress 

has banned such conflicts for auditors and I believc a similar ban should be enacted for 

proxy advisors. While disclosure of these conflicts would bc helpful, it is, in and of 

itsel f, insu fficient. 

3. Regulation and Oversight. Proxy advisory services provide a useful source of data and 

infonnation. It is important that information is credible, reliable, and timely. It must also 

be conflict free and done in a transparent fashion. As a result, I believe proxy advisory 

services should be subject to SEC oversight. 7 The SEC should establish a regulatory 

scheme that makes sense and can achieve the desired result. While some have called for 

all proxy advisory services to register as investment advisors, I am not sure that regimc is 

dcsigned to adequately (or smartly) address regulation of proxy advisors who typically do 

not give investment advice. Rather regulation of proxy advisors should ensure they: 

a. Fulfill a fiduciary obligation to recommend votes in a manner that is in the best 

intcrest of investors. 

b. Provide crcdible, accurate and timely research. 

c. Have a reasonable basis for recommendations they make. 

d. Remain free of conflicts. 

e. Have adequate training and compliance programs. 

f. Ensure that confidential data is securely maintained. 

4. Fiduciary Obligation. There has been discussion surrounding SEC regulations adopted in 

the last decade, and whether or not an asset manager can meet its fiduciary obligation by 

"outsourcing or farming out" the voting decisions to a proxy advisory firm. Whilc I 

believe the proxy advisory firms do providc invaluable research into voting decisions that 

are made, and accordingly, are important to fulfilling a fiduciary obligation, I do not 

believe the research report of a proxy advisory finn can or should replace the fiduciary 

obligation of an asset manager to those whose money it is managing. Accordingly, J 

believe the SEC and Department of Labor should clarify who has the principal fiduciary 

obligation when it comes to proxy voting; that the fiduciary obligation cannot be 

10 
356 


81762.319

outsourced; and that all proxy votes must bc done in a manner that is solely in the best 

interest ofthe investors in a fimd. In addition, it should be clarified that if a board of 

trustees of a mutual fund "outsource" the proxy voting to an affiliate of the mutual fund 

complex, that affiliate has a direct fiduciary obligation to the investors as well. 

5. Voting Standard. Today many of the largest companies in America have adopted a 

majority voting standard for election of directors. Yet in some limited instances directors 

have failed to receive the support of a majority of investors they represent. All too often 

such directors have remained on the boards, despite the lack of support for them from the 

owners of the business. As a result, I strongly believe a majority voting standard for 

directors should be enaeted. and directors who fail to win the support of a majority of 

voting investors should not be allowed to continue to represent the investors. 

Thank you Mr. Chairman. I would be happy to respond to any questions you or members of the 

Subcommittee might have. 

7 ISS IS registered as an investment advisor. GL was initially registered as an investment advisor when it was 

created. However, upon advice from counsel, including a former SEC director of the Investment Management 

Division, GL deregistered and continues to be dcregistered today. 

II 
357 


81762.320

Statement of 

Gary Retelny, President 

Institutional Shareholder Services Inc. 

to the 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

United States House of Representatives 

June 5, 2013 

Examining the Market Power and Impact of Proxy Advisory Firms 

To: The Honorable Scott Garrett 

Chairman 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Institutional Shareholder Services Inc. ("ISS" or the "Company") respectfully requests that 

the following statement be included in the record for the June 5, 2013 hearing convened by the 

Subcommittee on Capital Markets and Government Sponsored Enterprises on Examining the 

Market Power and Impact of Proxy Advisory Firms (the "Hearing"). 

Introduction 

ISS is a full-service proxy adviser with more than 25 years of experience helping 

institutional investors make informed proxy voting decisions, manage the complex process of 

voting their shares and report their votes to their stakeholders and regulators. ISS annually 

covers more than 40,000 shareholder meetings -- every holding in ISS' clients' portfolios -- in over 

100 developed and emerging markets worldwide. All proxy analysis at ISS is undertaken in 

accordance with a published analytical framework comprised of voting policy guidelines chosen by 

ISS' clients. ISS offers a wide range of proxy voting policy options, including both standard 

benchmark policies focused solely on maximizing shareholder value, and specialty policies that 
358 


81762.321

evaluate governance issues from the perspective of sustainability, socially-responsible investing, 

public funds, labor unions or mission and faith-based investing. ISS' voting policies and 

recommendations are the antithesis of one-size-fits-all. Case-by-case analytical frameworks, 

which take into account company size, financial performance and industry practices, drive the vast 

majority of ISS' vote recommendations. 

ISS also makes and implements proxy voting recommendations based on a client's 

specific customized voting guidelines, and may assist clients in developing such custom 

guidelines as well. In fact, more than one-third of ISS' institutional investor clients turn to us for 

research and vote recommendations that reflect their unique corporate governance 

philosophies or those of their underlying clients. Overall, ISS implements more than 400 custom 

voting policies on behalf of institutional investor clients. 

Except in extremely rare situations where a client has a conflict of interest and asks ISS to 

make a proxy voting decision on the client's behalf, ISS clients control both their voting policies 

and final vote decisions. They may, however, outsource the ballot processing and data 

management elements of their proxy voting operations to ISS. To this end, ISS often receives 

clients' ballots, co-ordinates with their custodian banks, executes votes based on client 

instructions, maintains voting records and provides reporting. By outsourcing these arduous 

administrative tasks, ISS' clients are able to devote more of their internal resources to making 

informed voting decisions. 

The Market Impact of Proxy Advisers 

ISS' clients use our proxy research and vote recommendations in a variety of ways. ISS' 

research and vote recommendations are just one source of information that clients use in 

arriving at their independent voting decisions. Many investors, for example, have internal 

research teams that conduct proprietary research and use ISS research to supplement their 

2 
359 


81762.322

own work. Some clients use ISS research as a screening tool to identify non-routine meetings 

or proposals. A number of our clients use the services of two or more proxy advisory services. 

It is unclear to what extent investors vote consistently with the recommendations of 

proxy advisory firms, particularly since investors use vote recommendations differently and such 

use is not easily monitored or quantified. Unfortunately, such complexity does not stop some 

commentators from asserting that a fairly large percentage of votes are "controlled by ISS." 

These misleading assertions have taken on a life of their own as they are repeated by other 

commentators who cite the initial statement as fact 

There is, however, independent empirical evidence to the contrary. University of 

Pennsylvania Law School Professor Jill Fisch, along with academic colleagues from New York 

University, have addressed this issue through quantitative analysis. In their paper, The Power 

of Proxy Advisors: Myth or Reality?, 1 the team analyzed the effect of proxy adviser 

recommendations on voting outcomes in uncontested director elections and concluded that 

media reports substantially overstate the extent of ISS' influence by failing to control for the 

underlying company-specific factors that influence voting outcomes. Controlling for these 

factors, Professor Fisch and her colleagues estimate that an ISS recommendation shifts 6 to 10 

percent of shareholder votes: 

Although superficial analyses suggest that an ISS recommendation can have a marginal 

impact of as much as 20%, and press reports state that ISS has the power to shift 20% 

to 30% of the shareholder vote, we conclude that these numbers are substantially 

overstated. In particular, our findings reveal that although an ISS recommendation has 

independent value, this value is greatly reduced once we take into account the 

company- and firm-specific factors that are important to investors. Depending on the 

test, we find that the impact of an ISS recommendation ranges from 6% to 13% for the 

median company. Overall, we consider it likely that an ISS recommendation shifts 6% to 

1 Choi, Stephen J, Fisch, Jill E. and Kahan, Marcel, The Power of Proxy Advisors: Myth or Reality? 

Emory Law Journal, Vol. 59, p. 869, 2010; University of Penn, Institute for Law & Economics Research 

Paper No. 10-24. Available at SSRN: http://ssrn.com/abstract=1694535. 

3 
360 


81762.323

10% of shareholder votes-a material percentage but far less than commonly attributed 

to ISS.2 

The authors suggest that a major component of this influence may stem from ISS' role 

as information agent: 

Furthermore, we find evidence that ISS's power is partially due to the fact that ISS (to a 

greater extent than other advisors) bases its recommendations on factors that 

shareholders consider important. This fact and competition among proxy advisors place 

upper bounds on ISS's power. Institutional Shareholder Services cannot issue 

recommendations arbitrarily if it wants to retain its market position. Doing so would lead 

institutional investors to seek the services of other proxy advisory firms. Thus, ISS is not 

so much a Pied Piper followed blindly by institutional investors as it is an information 

agent and guide, helping investors to identify voting decisions that are consistent with 

their existing preferences. 3 

This assessment is consistent with ISS' experience of how our clients actually use our 

proxy research and vote recommendations. It is also in line with a recent survey of asset 

managers by Tapestry Networks that found proxy advisory firms' "role as data aggregators" has 

become increasingly important to asset managers: 

Across the board, participants in our research said they value proxy firms' ability to 

collect, organize, and present vast amounts of data, and they believe smaller asset 

managers are more reliant on those services. Nonetheless, participants emphasized 

that responsibility for voting outcomes lies with investors. 4 

Proxy Advisers and the Investment Adviser Regulatory Regime 

ISS has been registered with the SEC as an investment adviser since 1997. While some 

suggest that the investment adviser regulatory regime is ill-suited to proxy advisers, that view 

Id. at 905-06. 

Id. at 906. 

Bew, Robyn and Fields, Richard, Voting Decisions at US Mutual Funds: How Investors Really Use 

Proxy Advisers (June 2012) at 2. Available at SSRN: http://ssrn.com/abstract=2084231. "Between 

November 2011 and March 2012, on behalf of the IRRC Institute, Tapestry Networks undertook an 

extensive inquiry into US asset managers' voting decision processes, as well as their views on the role 

proxy advisory firms play in those processes. In addition to reviewing major academic studies and current 

literature on the topic, [Tapestry] interviewed senior executives from 19 leading North American asset 

management firms and their affiliates, as well as academics, proxy advisory firms, proxy solicitors, and 

other stakeholders. In total, the investors [Tapestry] interviewed account for over $15.4 trillion in assets 

under management, or more than half of the assets under management in the United States." Id. at 1, 

4 
361 


81762.324

misapprehends the nature of such regulation. The Investment Advisers Act of 1940 ("Advisers 

Act") defines an investment adviser as a person who, for compensation and as part of a regular 

business, advises others about the value of securities or whether to buy or sell securities, or who 

issues reports or analyses about securities" Contrary to popular belief, the term is not 

synonymous with asset manager. In its 2010 Concept Release on the U.S. Proxy System, the 

SEC explained the applicability of the Advisers Act to proxy advisers as follows: 

[Pjroxy advisory firms receive compensation for providing voting recommendations and 

analYSis on matters submitted for a vote at shareholder meetings .... We understand that 

typically proxy advisory firms represent that they provide their clients with advice designed 

to enable institutional clients to maximize the value of their investments. In other words, 

proxy advisory firms provide analyses of shareholder proposals, director candidacies or 

corporate actions and provide advice concerning particular votes in a manner that is 

intended to assist their institutional clients in achieving their investment goals with respect 

to the voting securities they hold. In that way, proxy advisory firms meet the definition of 

investment adviser because they, for compensation, engage in the business of issuing 

reports or analyses concerning securities and providing advice to others as to the value of 

securities'" 

While some aspects of the investment adviser regulatory regime are directed exclusively 

at asset managers, many of the regime's core requirements apply with equal force to managers 

and research-oriented firms like proxy advisers. In this regard, the Advisers Act and related rules 

oblige proxy advisers to: 

o implement a Code of Ethics; 

o designate a Chief Compliance Officer; 

o adopt a comprehensive set of compliance procedures -- including procedures 

relating to proxy voting -- reasonably designed to prevent, detect and correct 

violations of the Advisers Act; 

o at least annually assess the sufficiency of the compliance procedures and the 

effectiveness of their implementation; 

o maintain a comprehensive set of books and records; 

o make full disclosure to clients and prospective clients about the adviser's business 

and any potential conflicts of interest related thereto. 

5 Advisers Act Section 202(a)(11) [15 USC BOb-2(a)(11)]. 

6 Concept Release on the US. Proxy System, SEC ReI. No. IA-3052 (July 14, 2010) at 109-110, 75 Fed 

Reg. 42981,43010 (July 22, 2010). 

5 
362 


81762.325

Underlying all these obligations is the fundamental principle that an investment adviser is a 

fiduciary. In the SEC's words: 

The Supreme Court has construed Section 206 of the Advisers Act as establishing a 

federal fiduciary standard governing the conduct of investment advisers. The Court stated 

that '[t]he Advisers Act of 1940 reflects a congressional recognition of the delicate fiduciary 

nature of an investment advisory relationship as well as a congressional intent to eliminate 

or at least to expose, all conflicts of interest which might incline an investment adviser --

consciously or unconsciously -- to render advice which was not disinterested.' As 

investment advisers, proxr advisory firms owe fiduciary duties to their advisory clients. 

(internal citations omitted). 

In view of the Hearing's focus on conflicts of interest in the proxy adviser industry, the 

question that begs to be asked is not why ISS is registered as an investment adviser, but why 

certain of its competitors are not. In order to enhance investor protection, ISS submits that all 

institutional proxy advisers should be subject to the extensive conflict management and disclosure 

requirements that exist today under the Advisers Act. There is no need for a new regulatory 

regime in this area. 

The Advisers Act Proxy Rule and the Use of Third-Party Proxy Advisers 

In January 2003, under the leadership of then-Chairman Harvey Pitt, the SEC adopted 

Advisers Act Rule 206(4)-6 to address an adviser's fiduciary obligations when the adviser is 

authorized to vote client proxies.' In this regard, the rule requires advisers to adopt proxy voting 

policies and procedures, describe those policies and procedures to clients and tell clients how to 

obtain information about how their votes were cast. 

The policies and procedures required under the rule must be reasonably designed to 

ensure that when an adviser votes a client's proxies, it does so in the client's best interests. This 

7 Id. at 110, 75 Fed. Reg. at 43010, quoting SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 

191-192 (1963). 

• Proxy Voting by Investment Advisers, SEC Release No. IA-2106 (Jan. 31, 2003), 68 Fed. Reg. 6585 

(Feb. 7, 2003) ("Proxy Rule Release"). At the same time it addressed proxy voting under the Advisers Act, 

the Commission adopted parallel requirements for mutual funds under the Investment Company Act of 1940. 

Disclosure of Proxy Voting Policies and Proxy Voting Records by Registered Management Investment 

Companies, SEC Release No. IC-25922 (January 31, 2003), 68 Fed. Reg. 6564 (Feb. 7, 2003). 

6 
363 


81762.326

means, among other things, the policies and procedures must describe how the adviser 

addresses any material conflicts between its interests and those of its clients with respect to proxy 

voting. 9 Because different advisers face different types of conflicts, the SEC rejected a one-sizefits-all approach to crafting policies and procedures. However, in adopting Rule 206(4)-6, the 

Commission noted a variety of ways in which conflicts could be addressed, including through the 

use of third-party advisers. In the Commission's words: 

[Aln adviser could demonstrate that the vote was not a product of a conflict of interest if it 

voted client securities, in accordance with a pre-determined policy, based upon the 

recommendations of an independent third party.'0 

The following year, the staff of the SEC's Division of Investment Management issued a noaction letter to ISS addressing the manner in which a registered investment adviser could --

consistent with its fiduciary duties to its clients determine the independence of a third-party 

proxy advisory service." In this regard, the staff explained: 

Whether an investment adviser breaches or fulfills its fiduciary duty of care when 

employing a proxy voting firm depends upon all of the relevant facts and circumstances. 

Consistent with its fiduciary duty, an investment adviser should take reasonable steps to 

ensure that, among other things, the firm can make recommendations for voting proxies in 

an impartial manner and in the best interests of the adviser's clients. Those steps may 

include a case by case evaluation of the proxy voting firm's relationships with Issuers, a 

thorough review of the proxy voting firm's conflict procedures and the effectiveness of their 

implementation, and/or other means reasonably designed to ensure the integrity of the 

proxy voting process .... An investment adviser should have a thorough understanding of 

the proxy voting firm's business and the nature of the conflicts of interest that the business 

presents, and should assess whether the firm's conflict procedures negate the conflicts. '2 

9 Material conflicts could arise where the adviser has a business or personal relationship with a company 

whose management is soliciting proxies, with participants in a proxy contest, or with candidates for corporate 

directorships. 

10 Proxy Rule Release at 5, 68 Fed. Reg. at 6588. 

11 Institutional Shareholder Services Inc., 2004 SEC No-Act. LEXIS 736 (September 15, 2004); see also 

Egan-Jones Proxy Services, 2004 SEC No-Act. LEXIS 636 (May 27, 2004). Contrary to Chaimnan Pitt's 

surprising assertion at the Hearing, the Staffs letter to ISS was neither unauthorized nor unusual, but rather 

was appropriate interpretive guidance regarding a fiduciary standard the Commission itself had articulated. 

12 Institutional Shareholder Services, Inc., 2004 SEC No-Act. LEXIS 736 at '4-5 

7 
364 


81762.327

The staff went on to state that because a proxy advisory firm's business andlor conflict 

procedures could change over time, the investment adviser has a fiduciary duty to monitor a thirdparty service provider's independence on an ongoing basis, Thus, contrary to assertions made at 

the Hearing, the staff did not authorize advisers to outsource their fiduciary duties relating to proxy 

voting, Instead, the staff explained the steps advisers should take to satisfy those duties when 

using third-party proxy advisory services, 

ISS' Approach to Managing Conflicts of Interest 

ISS' institutional investor clients have taken the SEC and its staffs guidance on fiduciary 

obligations in proxy voting to heart, Both before engaging ISS to render vote recommendations 13 

and periodically thereafter, these clients undertake a thorough examination of the ways in which 

ISS manages potential conflicts of interest 

ISS mitigates conflicts, first and foremost, by being a transparent, policy-based 

organization, Its use of a series of published voting policies provides a very practical check and 

balance that ensures the integrity and independence of ISS' analyses and vote recommendations, 

While these policies allow analysts to consider company- and market-specific factors in 

generating vote recommendations, the existence of a published analytical framework, coupled 

with the fact that vote recommendations are based on publicly-available information, allows ISS 

clients to continuously monitor the integrity of ISS advice,14 

Furthermore, pursuant to its own obligations under the investment adviser regulatory 

regime, ISS has undertaken a comprehensive risk assessment to identify specific conflicts of 

interest related to its operations and has adopted compliance controls reasonably designed to 

manage those risks. One of the primary components of its compliance program is a Code of 

Ethics that prescribes standards of conduct for ISS and its employees, 

13 As explained above, clients rarely delegate decision-making authority over proxy votes to ISS, 

14 Each ISS analysis includes a URL for a direct hyperlink to ISS' summary voting guidelines for easy 

access by users of our research, 

8 
365 


81762.328

The Code of Ethics affirms ISS' fiduciary relationship with its clients and obligates ISS and 

its employees to carry out their duties solely in the best interests of clients and free from any 

compromising influences and loyalties. The Code also contains restrictions on personal trading 

designed to prevent employees from improperly trading on, or benefiting from, inside information, 

client information and/or ISS' voting recommendations. The Code emphasizes the requirement 

that all research for clients be rendered independently of employees' personal interests. 

In order to ensure compliance with the Code of Ethics, ISS conducts periodic training 

sessions for employees and requires employees to affirm their commitment to compliance on an 

annual basis. Furthermore, ISS regularly monitors the sufficiency of the Code and the 

effectiveness of its implementation. 

Conflicts in Connection with Affiliated Corporate Services 

Another critical component of the ISS compliance program is the firewall it maintains 

between its institutional business and the corporate services offered by its subsidiary, ISS 

Corporate Services, Inc. ("ICS"). This firewall includes the physical and functional separation 

between ICS and ISS, with a particular focus on the separation of ICS from the ISS Global 

Research team. A key goal of the firewall is to keep the ISS Global Research team from learning 

the identity of ICS' clients, thereby ensuring the objectivity and independence of ISS' research 

process and vote recommendations. The firewall mitigates potential conflicts via several layers of 

separation: 

o ICS is a separate legal entity from ISS. 

o ICS is physically separated from ISS, and its day-tO-day operations are separately 

managed. 

o ISS Global Research team works independently from ICS. 

o ICS and ISS staff are prohibited from discussing the identity of ICS clients. 

o Institutional analysts' salaries, bonuses and other forms of compensation are not 

9 
366 


81762.329

linked to any specific ICS activity or sale. 

o ICS explicitly tells its corporate clients that ISS will not give preferential treatment 

to, and is under no obligation to support, any proxy proposal of an ICS client. ICS 

further informs its clients that ISS' Global Research team prepares its analyses 

and vote recommendations independently of, and with no involvement from, ICS. 

o ISS clients can request a list of alllCS clients. 

As is the case with the Code of Ethics, ISS maintains a robust training and monitoring 

program regarding the firewall. This program includes quarterly tests of the firewall's integrity, 

new-hire orientation, and review of certain marketing materials and disclosures. There also is an 

ethics hotline available to both ICS and ISS staff for reporting issues of potential concern. 

Conflicts in Connection with ISS' Parent Company 

In addition to managing conflicts arising from the corporate advisory services of its ICS 

affiliate, steps have been taken to protect ISS' independence from its ultimate parent corporation, 

MSCI Inc. First, ISS recuses itself from making voting recommendations regarding MSCI proxy 

issues, and instead supplies clients with the analyses of multiple other proxy advisory firms to 

inform their vote decision. Furthermore, the MSCI Board of Directors has adopted resolutions 

stating that: (i) the formulation, development and application of ISS' proxy voting policies 

(including the establishment of voting standards), proxy analyses and vote recommendations are 

and shall remain the sole responsibility of ISS at all times; (ii) the non-executive members of the 

MSCI Board of Directors shall have no role in formulating, developing or implementing ISS' proxy 

voting pOlicies, proxy analyses and/or vote recommendations; and (iii) the non-executive members 

of the MSCI Board of Directors shall not be informed of the content of any ISS proxy analyses or 

vote recommendations prior to their publication or dissemination. 

The MSCI Inc. Board of Directors also has adopted a Conflicts of Interest Policy related to 

"Director Affiliated Companies" to address any potential conflicts of interest posed by other public 

company board seats held by any MSCI Inc. director. 

10 
367 


81762.330

Conflicts Within the Institutional Advisory Business 

Conflicts theoretically may also arise where an ISS client (or a client of MSCI) is also a 

public company whose own proxies are the subject of analyses and voting recommendations, 

or other advisory research report, or where the Company is called upon to analyze and vote on 

shareholder proposals propounded by a Company client. In order to manage conflicts in this 

area, the Company appends a conflict legend to each research report indicating that the issuer 

whose proxy is being analyzed may be a client of, or affiliated with a client of MSCI or its 

subsidiaries including, ISS or ICS. ISS is careful not to provide preferential treatment to 

shareholder proponents that are ISS proxy clients. 

Conflicts in Connection with Issuers' Review of Draft Analyses 

If, upon reviewing a draft proxy vote analysis, an issuer notifies ISS in writing of one or 

more factual inaccuracies in the draft, an ISS analyst may decide to change his or her proposed 

voting recommendation. In order to ensure the propriety of the interaction between the issuer and 

the analyst, the analyst's decision to change the vote recommendation must be reviewed by a 

senior analyst and appropriate records must be kept of the communication from the issuer and the 

voting decision. These records are subject to the Chief Compliance Officer's periodic review. 

Disclosure Regarding Potential Conflicts 

ISS provides its investor clients with an extensive array of information to ensure that they 

are fully informed of potential conflicts and the steps ISS has taken to address them. In addition 

to making full disclosure in the Form ADV brochure it delivers to each client, ISS supplies a 

comprehensive due diligence compliance package on its web site to assist clients and prospective 

clients in fulfilling their own obligations regarding the use of independent, third-party proxy voting 

firms. This package includes a copy of ISS' Code of Ethics, a description of other policies, 

procedures and practices regarding potential conflicts of interest and a description of the ICS 

11 
368 


81762.331

business. A copy of the MSCI Board of Directors Conflicts of Interest Policy related to DirectorAffiliated Companies is also available through the ISS web site. 

Moreover, each proxy analysis and research report ISS issues contains a legend 

indicating that the subject of the analysis or report may be a client of or affiliated with a client of 

ISS, ICS or another MSCI subsidiary. Each analysis and report also notes that one or more 

proponents of a shareholder proposal may be a client of ISS or one of its affiliates, or may be 

affiliated with such a party. Clients who wish to learn more about the relationship, if any, between 

ICS and the subject of an analysis or report are invited to contact ISS' Legal and Compliance 

Department for relevant details. This process allows ISS' proxy voting clients to receive the 

names of ICS clients without revealing that information to research analysts as they prepare vote 

recommendations and other research. Were the ICS relationship identified on the face of a proxy 

analysis or report, this critical information barrier would be destroyed. 

ISS believes that these extensive measures provide clients with a high degree of comfort 

that ISS has eliminated or is effectively managing the potential conflicts of interest its business 

entails. 

ISS' Commitment to Transparency 

In addition to transparency regarding its conflicts management policies, ISS also is 

committed to transparency in the formulation of its proxy voting policies and guidelines, collecting 

information from a diverse range of market participants through multiple channels.'5 

Each year, this policy-setting process begins with a Policy Survey seeking input from 

both institutional investors and corporate issuers in an effort to identify emerging issues that 

'5 For example, the 2013 comment period drew responses from investors (such as CalSTRS and T. 

Rowe Price), individual issuers (such as Comcast, eBay, Exxon Mobil and Fed Ex) and trade groups (such 

as the Business Roundtable, the Center on Executive Compensation, the National Association of 

Corporate Directors, the SOCiety of Corporate Secretaries and Governance Professionals and the U.S. 

Chamber of Commerce). 

12 
369 


81762.332

merit attention prior to the upcoming proxy season. Based on this feedback, ISS convenes a 

series of roundtables with various industry groups and outside issue experts to gather multiple 

perspectives on complex or contentious issues. As part of this process, ISS researchers 

examine academic literature, other empirical research and relevant commentary in an effort to 

uncover potential links between an issue and financial returns and/or risk. 

The ISS Global Policy Board, which is comprised of ISS' market research heads and 

subject matter experts, uses this input to develop its draft policy updates. Before finalizing 

these updates, ISS publishes them for an open review and comment period (modeled on the 

SEC's process for commenting on pending rule-making). This open comment period is 

designed to elicit objective, specific feedback from investors, corporate issuers and industry 

constituents on the practical implementation of proposed policies. For the past several years, all 

comments received by ISS have been posted verbatim to the ISS Policy Gateway on its public 

website, in order to provide additional transparency into the feedback we have received. Final 

updates are published in November, to apply to meetings held after February of the following 

year. 

To our knowledge, ISS is the only proxy adviser to gather, assess and incorporate 

market feedback into its institutional proxy voting policies and remains committed to a robust 

and transparent policy formulation process. 

Engagement Yields Better Research 

ISS' outreach is not confined to its policy-setting process. Robust engagement is an 

essential part of ISS' day-to-day operations. Each season, ISS engages with thousands of 

corporate executives, board members, institutional investors and other constituents via inperson meetings, conference calls and participation in industry events. 

13 
370 


81762.333

As a research organization, ISS encourages constructive dialogue on critical issues to 

ensure a deeper understanding of the company-specific facts and circumstances, which in turn 

informs its proxy analyses and recommendations. As part of the year-round research process, 

ISS analysts have regular interactions with company representatives, institutional shareholders, 

shareholder proponents and other parties to gain inSight into key issues. The issues discussed 

can range from general policy perspectives to specific ballot items. 

The purpose of such engagement is for ISS to obtain, or communicate clarification 

about governance and voting issues, in order to ensure that our research and policy-driven 

recommendations are based on the most comprehensive and accurate information available. 

Sometimes these conversations are initiated by ISS, and sometimes they are initiated by the 

issuer or shareholder. In contested situations, ISS ordinarily engages with both sides. 

Insights gleaned from these engagements are reflected in ISS' proxy advisory reports 

when the information is deemed to be useful in helping its institutional clients make a more 

informed voting decision. In those instances, ISS may consider including direct quotes from 

statements made by participants in the meeting(s). At the discretion of the analyst, a brief 

"engagement summary" may be included on the front page of the analysis report. 

In March 2012, ISS set a new high water mark for transparency and responsiveness by 

establishing a Feedback Review Soard ("FRS"), chaired by ISS' President. The FRS provides 

an additional conduit for investors, executives, directors and other market constituents to 

communicate with ISS. 

ISS' Commitment to Accuracy and Completeness 

ISS goes to great lengths to ensure that its reports are complete and materially 

accurate. ISS has a myriad of policies and procedures to ensure the integrity of its research 

process. As explained above, ISS' analyses and recommendations are driven by publicly 

14 
371 


81762.334

disclosed and detailed policy guidelines in order to ensure consistency and to eliminate 

potential analyst implementation bias. 

Furthermore, prior to delivery to clients, each proxy analysis undergoes a rigorous 

internal review for accuracy and to ensure that the relevant voting policy has been applied. In 

the U.S., companies found in the Standard & Poor's 500 index generally receive an opportunity 

to review a draft analysis for factual accuracy prior to delivery of the analysis. ISS reviews other 

requests for review and comment on a case-by-case basis. All issuers may request and receive 

a free copy of the published copy of its ISS analysis of its shareholder meeting. 

ISS also conducts periodic SAS-70/SSAE 16 audits to ensure compliance with its 

internal control processes. ISS' research process is included in these audits. ISS believes that 

these controls reduce the chance that an analysis will be published with material errors and 

provide a correction mechanism after a report has been delivered. 

While ISS strives to be as accurate as possible, the research team does, infrequently, 

identify material factual errors in our reports, such as those relating to the agenda, data or 

research/policy application. When this happens, the research team promptly issues a "Proxy 

Alert" ("Alert") to inform clients of any corrections and, if necessary, vote recommendation 

changes. Alerts are distributed to ISS' institutional clients through the same ProxyExchange 

platform used to distribute our regular proxy analyses. '6 This ensures that the clients who 

received an original analysis will also receive the related Alert, which is attached to the 

company meeting. During the 2012 calendar year, ISS delivered Alerts for 537 (1.5 percent) of 

35,526 meetings covered around the globe. For the U.S. market, the 2012 correction rate was 

2.3 percent (152 of 6,532 meetings). 

16 An Alert is structured as an overlay on top of the original analysis; the first few pages show the 

corrected information and any related vote recommendation changers), but the original analysis lies 

underneath, and continues to reflect the original information. 

15 
372 


81762.335

ISS acknowledges that corporate issuers do not always agree with our vote 

recommendations. This is understandable given that these recommendations are not always 

aligned with those of the company's management and board. Simply put, the interests of the 

company's owners can and do conflict with those of management and the board from time to 

time. ISS would not be serving its investor clients if it did not highlight these cases. ISS notes, 

however, that when issuers dispute our analyses, the disputes generally relate to policy 

application (or the principles underlying the policies themselves), not the factual accuracy of the 

analysis. ISS remains committed to working with governance stakeholders to ensure that 

policies reflect the input of all parties. 

Conclusion 

As the foregoing discussion demonstrates, proxy advisers playa valuable role in the U.S. 

capital markets by helping institutional investors make informed decisions on how to vote their 

proxies. While proxy advisers often assist institutional investors in fulfilling their fiduciary duties of 

care and loyalty, such investors do not and cannot "outsource" those duties to the proxy advisers. 

As the empirical evidence shows, proxy advisers do not control the outcome of proxy voting in the 

United States. 

For their part, the proxy advisers are also fiduciaries, and are appropriately governed by 

the regulatory regime established under the Investment Advisers Act of 1940. That statute and 

the implementing rules adopted by the SEC oblige proxy advisers to assess, manage and 

disclose their conflicts of interest. ISS has done this by adopting a Code of Ethics and 

establishing a comprehensive set of conflict management procedures which it fully explains to 

clients and potential clients. 

ISS' commitment to transparency is reflected as well in the way in which it formulates its 

proxy voting policies and guidelines. By engaging with investors, issuers, and other market 

16 
373 


81762.336

participants, ISS is able to enhance the quality of its research, analysis, and vote 

recommendations, all with the goal of enabling its clients to make well-informed proxy voting 

decisions. 

ISS commends the Subcommittee for examining the role of proxy advisers in helping 

shareholders fulfill their important role in corporate governance. ISS also appreciates the 

opportunity to submit this statement and would be delighted to provide the Subcommittee with any 

additional information it desires regarding these critical issues. 

17 
374 


81762.337

June 4, 2013 

The Honorable Scott Garrett 

Chairman 

MUTUAL FUND DIRECTORS FORUM 

rbe FORDljor Fl'XD 11\DEPENDEXT DlRECTORS 

House Subcommittee on Capital Markets and 

Government Sponsored Enterprises 

2129 Rayburn House Office Building 

Washington, DC 20515 

Dear Chairman Garrett: 

As the Subeommittee considers the role of proxy advisory films, the Mutual Fund 

Directors Forum (MFDF) would like to provide you with a copy of a white paper we 

published entitled "Practical Guidance for Fund Directors on Oversight of Proxy Voting." 

This report discusses key decision points that mutual fund directors often consider when 

establishing proxy voting procedures and provides a summary of common proxy voting 

processes used throughout the mutual fund industry. 

We ask that our letter be included with the record of the hearing on lune 5 entitled 

"Examining the Market Power and Impact of Proxy Advisory Firms." The report can be 

found on our website at 

http://www.mfdf.orglimages/uploadsfnewsroom/Oversight of Proxy Voting.pdf. 

1501 M St. NW, Suite 1150 • Washington, DC 20037-1174. T: 202.507.4488· F: 202.507.4489 

www.mfdf.com 
375 


81762.338

Testimony of Sean Egan, 

Chief Executive Officer, Egan-Jones Rating Company 

To the Subcommittee on Capital Markets and 

Government Sponsored Enterprises 

"Examining the Market Power & Impact of Proxy Advisory Firms" 

.June 5,2013 

Chainnan Garrett, Vice Chaimlan Hurt, Ranking Member Maloney and members of the 

subcommittee: 

Proxy advisers are critical to the proper functioning of modern capital markets. 

Institutional investors of all sorts rely on proxy advisers to present a fair, balanced view so 

that those investors can properly fulfill their fiduciary obligations. l3y acting as agents for 

institutional investors, proxy advisers collect, analyze, and make recommendations to 

institutional investors Oil the various agenda items in proxy statements with the aim of 

protecting shareholders, Unfortunately, the process has beell skewed such that investor 

protection has been all too ollen forgotten. 

The first and only obligation of a proxy advisory service is to assist clients in enhancing 

and protecting shareholder value. Unfortunately some proxy advisers appear to have 

substituted social, public policy, and even political objectives ahead of fiduciary 

obligations to institutional investors. The recent annual JPMorgan proxy vote 

underscored a significant disconnect between the positions taken by proxy advisers ISS 

and Glass Lewis and the views of the majority of the investment market. Like most 

holders of JP Morgan shares, Egan-Jones Proxy Services recommended that Jamie Dimon 

be retained and that the role of the CEO and Chairman not be separated. We were in 

concert not only with the bulk of the investment community but also with nearly every 

prominent CEO who spoke out on the subject including Warren l3uffett, Dave Cote of 

Honeywell, and John Mack of Morgan Stanley, and Dick Kovacevich of Wells Fargo. 

Egan-Jones is focused on enhancing and protecting shareholders value. We let nothing -

especially ideology - interfere with our obligation to clients. We believe institutional 

investors and other fiduciaries are best served by utilizing a proxy adviser whose views 

are aligned with theirs and who is focused on investor protection. 

61 Station Road. Haw!/ford, Pel1m,y/vania, L\4 190-11 
376 


81762.339

Statement of 

Ann Yerger 

Executive Director 

Council of Institutional Investors 

to the 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

of the 

Committee on Financial Services 

United States House of Representatives 

June 5, 2013 

Examining the Market Power and Impact of Proxy Advisory Firms 
377 


81762.340

Dear Mr. Chairman and Ranking Member Maloney: 

The Council of Institutional Investors ("CII") respectfully requests that the following statement be 

included in the record for the June 5, 2013 hearing convened by the Subcommittee on Capital 

Markets and Government Sponsored Enterprises on Examining the Market Power and Impact of 

Proxy Advisory Firms. CII notes that the two largest U.S. proxy advisory firms, Glass Lewis & 

Co. ("Glass Lewis") and Institutional Shareholder Services ("ISS") are non-voting members of 

CII, paying an aggregate of $24,000 in annual dues-less than 1.0 percent of Cll's membership 

revenues. In addition, CII is a client of ISS, paying approximately $19,600 annually to ISS for its 

proxy research. 

CII 

Founded in 1985, CII is a nonpartisan, not-far-profit association of public, labor and corporate 

employee benefit funds with assets collectively exceeding $3 trillion. CII is a leading advocate 

for improving corporate governance standards for U.S. public companies and strengthening 

investor rights. 

CII members are diverse. Voting members include funds such as the New Jersey Division of 

Investment, the New York State Common Retirement Fund, Johnson & Johnson, and the IUECWA Pension Fund. Non-voting members include asset managers such as BlackRock, TIAACREF, State Street Global Advisors, and Capital Group Companies. ' 

CII members are responsible for investing and safeguarding assets used to fund retirement 

benefits for millions of participants and beneficiaries throughout the U.S. They have a 

1 See Attachment for a complete list of the Council's current members. For more information about the 

Council, please visit http://www.cii.orgimembers. 
378 


81762.341

significant commitment to the U.S. capital markets, with the average CII member investing 

nearly 60 percent of its entire portfolio in U,S, stocks and bonds" 

They are also long-term, patient investors due to their far investment horizons and their heavy 

commitment to passive investment strategies, Because these passive strategies restrict 

Council members from exercising the "Wall Street walk" and selling their shares when they are 

dissatisfied, corporate governance issues are of great interest to our members, 

One way CII members are engaged in corporate governance issues is through proxy voting, 

Owning stock in a company gives CII members and other investors the right to vote on 

important matters concerning corporate strategic decisions, such as significant mergers or 

acquisitions, and governance issues, such as the election of directors, 

Because of the significance of the issues addressed on corporate ballots, the proxy vote is 

considered part of the underlying value of a stock, For CII members and others with fiduciary 

duties, proxy voting is also an obligation. 

Cil's corporate and labor fund members are subject to the 1974 Employee Retirement Income 

Security Act ("ERISA"), which requires fund fiduciaries to act solely in the best interests of plan 

participants and beneficiaries. While Cil's public pension plans are not subject to ERISA, many 

state and local legislatures have adopted standards closely modeled on ERISA rules. And CII 

member funds sponsored by private trusts and tax-exempt institutions (such as universities and 

churches) also tend to follow ERISA fiduciary standards, 

2 Council of Institutional Investors, Asset Allocation Survey 2009,4 (on file with CII) ("Domestic stocks 

and bonds accounted for 57.5 percent of the average portfolio of surveyed Council members,"). 

2 
379 


81762.342

As fiduciaries, ell members have a variety of specific duties regarding proxy voting, including: 

Fiduciaries must not vote based on their private interests, but rather to maximize the 

economic value of plan holdings; 

Votes must be cast on each issue that has an impact on the economic value of stock; 

Voting decisions should be based on a careful analysis of the vote's impact on the 

economic value of the investment; and 

If proxy voting is delegated, plan fiduciaries have duty to monitor proxy voting 

procedures and votes. 

Proxy Advisory Firms 

Proxy advisory firms have been in business for decades. Today, two firms-Glass Lewis and 

ISS-dominate the business, and several other smaller firms provide proxy advice and voting 

services. Most ell voting and non-voting members are clients of one or more of those firms. 

ell believes that the influence of the proxy advisory firms has significantly declined in recent 

years, as asset managers, pension funds and others have taken greater interest in proxy voting 

and have developed in house expertise to address proxy-related issues. And others share ell's 

view. The Wall Street Journal's recent article entitled "For Proxy Advisers, Influence Wanes," 

noted: 

The landscape for proxy advisers is getting rockier. 

Big firms that sell recommendations on how to vote in corporate elections 

are losing some of their relevance, as companies more aggressively court 

key investors ahead of big votes and those investors handle more of the 

voting analysis themselves. 3 

3 Joann Lubin & Kristen Grind, For Proxy Advisers, Influence Wanes, Wall SI. J., May 22, 2013, 

http://online.wsj.com/article/SB 10001424127887323336104578499554143793198. him!. 

3 
380 


81762.343

Possible Steps Forward 

CII believes that proxy advisory firms should: 

Register as investment advisers under the Investment Advisers Act of 1940; 

Provide substantive rationales for vote recommendations; 

Minimize conflicts of interest and disclose details of potential conflicts, including those 

involving companies or resolution sponsors, in the applicable meeting report; 

Correct material errors promptly and notify affected clients as soon as practicable; and 

Provide transparency into the general methodologies-without compromising proprietary 

models-used to make recommendations, 

In addition, CII believes interpretive guidance and/or additional empirical data from the Staff of 

the U,S, Securities and Exchange Commission ("SEC" or "Commission") would be helpful in the 

following two areas: Specifically: 

1, We do not believe that the SEC's rules, or interpretations thereof, require investment 

advisers to vote al/ proxies, We, however, recognize that there may be confusion 

regarding this issue, We, therefore, believe SEC Staff interpretive guidance would be 

helpful. 

We note that the SEC's 2003 release adopting Rule 206(4)-06 under the Investment 

Advisers Act requires advisers that have authority to vote proxies to adopt pOlicies and 

procedures reasonably designed to ensure that the adviser votes proxies in the best 

interests of clients, disclose to clients information about those policies and procedures, 

and disclose to clients how they may obtain information on how the adviser has voted 

4 
381 


81762.344

their proxies4 Rule 206(4)-6, however, does not contain any language requiring that all 

proxies be voted. One sentence in the adopting release, taken out of context, could be 

read to support such a mandate. It states, "The duty of care requires an adviser with 

proxy voting authority to monitor corporate events and to vote the proxies."s However, 

the footnote to that sentence immediately clarifies, "As we discuss later in this Release, 

we do not mean to suggest that an adviser that does not exercise every opportunity to 

vote a proxy on behalf of its clients would thereby violate its fiduciary obligations to those 

clients under the Act."" Moreover, later in the Release, the Commission explains: 

We do not suggest that an adviser that fails to vote every proxy would 

necessarily violate its fiduciary obligations. There may even be times 

when refraining from voting a proxy is in the client's best interest, such as 

when the adviser determines that the cost of voting the proxy exceeds the 

expected benefit to the client. 

We note that the above language is very similar to the language from a U.S. Department 

of Labor's 2008 interpretative bulletin addressing proxy voting obligations of ERISA 

fiduciaries. 7 

2. We do not believe that, at this time, there is sufficient empirical evidence suggesting that 

institutional investors are abdicating and outsourcing their voting responsibilities. 

However, we recognize that there may be disagreement over this issue. We, therefore, 

believe the SEC should gather, as part of its inspection process, data on the proxy 

voting practices of investment advisers. This empirical data could provide a factual 

basis for possible future reforms. 

417 CFR 275.206(4)-6: SEC, Final Rule: Proxy Voting by Investment Advisors, Release No. IA 2106,79 

~Jan 31,2003) 

" SEC, Final Rule: Proxy Voting by Investment Advisers, Release No. IA - 2106,79 (Jan. 31. 2003). 

Id. n.3. 

7 29 C.F.R § 2509.08-2. 

5 
382 


81762.345

While CII believes some reforms of proxy advisory firms may be appropriate, we oppose 

regulatory involvement in methodologies used by proxy advisors to determine vote 

recommendations. We are also concerned about proposed reforms to require proxy advisory 

firms to submit advance drafts of their reports to the subject companies. We believe that such a 

mandate could result in at least two problems for shareowners. First, it could create an inherent 

conflict that may undermine the independence of the report. Second, it could cause 

unnecessary and costly delays in the distribution of the report. 

In addition, we question the need for certain other possible reforms, including some premised 

on the view that the SEC lacks authority over proxy advisory firms. We believe the SEC 

currently has significant and sufficient authority over proxy advisory firms, regardless of whether 

they are registered as investment advisers. For example, we note that while proxy advisers are 

exempt from the requirement in the SEC's proxy rules that a proxy statement be filed in 

connection with a solicitation; they remain covered by Rule 14a-9, the SEC's general anti-fraud 

rule applicable to proxy solicitations. The SEC's 2010 proxy plumbing release discussed this 

exemption and confirmed that "proxy voting advice remains subject to the prohibition on false 

and misleading statements in Rule 14a-9.'" As a result, proxy advisors can be liable under the 

securities laws for making a materially false or misleading statement in a recommendation. 

Complaints from issuers that advisors make recommendations based on inaccurate information 

could be addressed under Rule 14a-9, which both the SEC and private parties can enforce, so 

long as the information was material to the voting decision. 

More generally, we believe that the following three additional factors should be given careful 

consideration before pursuing any possible proxy advisory reforms, including those generally 

supported by CII: (1) institutional investor proxy voting practices; (2) the voting power of proxy 

8 SEC, Concept Release on the U.S. Proxy System, Release Nos. 34-62495; IA-3052; IC-29340 (JuL 14, 

2010) 

6 
383 


81762.346

advisory firms; and (3) the market power of proxy advisory firms. The following is a summary of 

our views on each of those factors: 

1. Institutional Investor Proxy Voting Practices 

Today institutional investors are the dominant owners of U.S. public companies. 

According to the Conference Board 2010 Institutional Investor Report, institutional 

investors owned 50.6 percent of the U.S. equity market at the more than 70 percent of 

the largest U.S. companies and nearly 51 percent of all U.S. equities. 9 

In many cases, institutional ownership is concentrated with a company's largest owners. 

The Conference Board 2010 report found the 5 largest owners of the 25 largest U.S. 

companies comprised, on average, nearly 28 percent of the institutional ownership of the 

companies, while the 25 largest owners comprised, on average, nearly 54 percent of the 

institutional ownership of the companies. '° 

I nstitutional investors are not monolithic. They are extremely diverse and include mutual 

funds, state and local pension funds, and insurance companies. According to the 2010 

Conference Board report, mutual funds are the dominant institutional owner, comprising 

more than 41 percent of all institutional shares and owning 20.9 percent of U.S. 

equities. '1 In contrast, state and local pension funds comprise 14.8 percent of 

institutional shares and own 7.5 percent of U.S. equities. '2 

9 The Conference Board, The 2010 Institutional Investment Report: Trends in Asset Allocation and 

Portfolio Composition 5 (Nov. 2010). 

10 Id. aI29-46. 

"/d. a126. 

12 Id. 

7 
384 


81762.347

Institutional investors are not identical when it comes to proxy voting. They may vote 

their shares internally using fund staff. They may delegate proxy voting to asset 

managers or third-party agents. They may vote based on their own internal proxy voting 

guidelines. They may vote based on proxy advisor recommendations. In many cases 

they use the services of proxy advisory firms. 

It is important to note that clients of proxy advisory firms are not necessarily voting 

based on the firms' recommendations. They may have their own guidelines and use the 

proxy advisory firms' research to assist with their voting. 

As indicated earlier, there is no empirical evidence demonstrating that institutional 

investors blindly follow the recommendations of proxy advisors. Of note, our survey of 

the largest public pension systems and institutional asset managers found that nearly all 

have their own proxy voting guidelines and use proxy advisory firms simply for the 

research; they do not vote based on the advisory firm's voting recommendations. 

More specifically, our 10 largest voting members, with total assets aggregating $1.2 

trillion, vote based on fund-developed proxy voting guidelines. They generally are 

clients of one or more proxy advisory firms. However, their use of the firms is generally 

limited to (1) using the advisory firms' research to assist with their internal proxy voting 

or (2) delegating the execution of voting to the advisory firms but based on their funddeveloped guidelines. 

Asset managers also differ in terms of how they handle their proxy voting. In recent 

years, we have witnessed a sea change in terms of how the largest U.S. asset 

managers handle their proxy voting responsibilities. Today, the largest U.S. asset 

managers generally have dedicated staff that specializes in proxy voting. Those firms 

8 
385 


81762.348

have their own proxy voting guidelines; they do not vote based on the advisory firms' 

recommendations. Similar to the large public fund members of CII, they generally are 

clients of one or more proxy advisory firms. The advisory firms provide research or vote 

their proxies based on the managers' guidelines. 

2. Voting Power of Proxy Advisory Firms 

Some observers have criticized proxy advisory firms for having a disproportionate 

influence on voting outcomes. The estimates of the voting influence of the proxy 

advisory firms vary. 

A study of mutual funds by Professors Stephen Choi, Jill Fisch and Marcel Kahan found 

that funds accounting for 25 percent of assets virtually always followed management 

recommendations, while funds accounting for less than 10 percent of the assets 

exhibited a strong tendency to follow ISS recommendations. 13 Professors Choi, Fisch 

and Kahan also found that a recommendation from ISS shifts the outcome of a vote by a 

mere 6 to 10 percent of votes cast. 14 In contrast, a study by Professors David Larcker, 

Allan L. McCall and Gaizka Ormazabal found that opposition by a proxy advisor results 

in a "20 percent increase in negative votes cast.,,15 

Regardless, interpreting these statistics is difficult. Correlation between voting results 

and proxy advisor recommendations is not causation and should not be interpreted that 

votes were cast based solely on the recommendations of the advisory firms. As noted 

13 Stephen Choi et aI., Voting Through Agents: How Mutual Funds Vote on Director Ejections (Aug. 17, 

2011); University of Pennsylvania, Institute for Law & Economics Research Paper No. 11-28; NYU Law 

and Economics Research Paper No. 11-29. Available at SSRN: http://ssrn.com/abstract=1912772 or 

http://dx.doi.org/10.2139/ssrn.1912772. 

14 Stephen Choi, et aI., The Power of Proxy Advisors: Myth or reality?, 59 Emory L. J. 869 (2010). 

15 David F. Larcker et aI., Outsourcing Shareholder Voting to Proxy Advisory Firms 7 (May 10,2013); 

Stanford Graduate School of Business Research Paper No. 2105. Available at SSRN: 

http://ssrn.com/abstract=2101453 or http://dx.doLorg/10.2139/ssrn.2101453. 

9 
386 


81762.349

earlier, CII believes that most large institutions develop and vote based on their own set 

of voting guidelines. In many cases proxy advisor recommendations are simply 

consistent with the policies adopted by institutional investors. 

This alignment is not surprising given that proxy advisor policies are not developed in a 

black box, removed from marketplace input. ISS policies, for example, are not 

developed in a vacuum. Every year ISS conducts an extensive survey on emerging 

governance and proxy voting issues, gathering perspectives from interested market 

participants. The survey is followed by in-depth roundtables and a review of relevant 

empirical evidence or academic literature. Before a new policy is adopted, ISS solicits 

comments from the public. This extensive due diligence means that ultimately ISS 

policies reflect the views of the marketplace-not the reverse. 

Moreover, empirical evidence does not support the theory that ISS determines the fate 

of voting outcomes. As illustrated in the table on the following page, in 2012 ISS 

opposed board nominees 8.5 percent of the time, yet the incidence of a nominee failing 

to win majority support was less than 0.5 percent. Fewer than one in 10 shareowner 

proposals requesting an independent board chair receives majority support, despite the 

fact that ISS recommends in favor of these proposals approximately three times out of 

every four. 

10 
387 


81762.350

Key proposals and outcomes in 2012 

Received less Average 

Proposal type Proposals Average than majority Opposed support if 

support by ISS opposed by support ISS 

Elect director 16,993 95.0% 0.4% 8.5% 82.0% 

(uncontested) 

Advisory vote 

on executive 2,288 90.8% 2.5% 13.2% 65.0% 

compensation 

Shareowner 

proposal 

requesting 55 35.6% 92.7% 25.5% 24.1% 

independent 

board chair 

Source. ISS Voting Analytlcs database. Data covers Russell 3,000 With available vote results. 

3. Market Power of Proxy Advisory Firms 

Some observers have criticized proxy advisory firms for having a disproportionate 

influence on the design of corporate governance. Those observers believe that 

companies feel compelled to change their corporate governance practices to ensure 

positive recommendations from the proxy advisory firms. If true, CII believes such a 

strategy is misguided. 

CII believes that companies should be more concerned with the views of its 

shareowners than the views of the proxy advisory firms. And the largest institutional 

investor clearly agrees. In January 2012, Blackrock sent a leiter to 600 of its biggest 

holdings, encouraging them to engage with the firm. In the letter, it was reported that 

CEO Laurence D. Fink stated: "We think it is particularly important to have such 

discussions - with us and other investors - well in advance of the voting deadlines for 

11 
388 


81762.351

your shareowner meeting and prior to any engagement you may undertake with proxyadvisory firms."'6 

CII agrees that company engagement with shareowners is the best way to gauge 

shareowner sentiments. In doing so, companies will likely find that on some issuessuch as classified boards, poison pills and majority voting for directors-institutional 

investors frequently have a "one size fits all" approach that is consistent with proxy 

advisor recommendations. On others, such as "say on pay," they will likely find that 

institutional investors are comfortable giving companies the flexibility to craft 

compensation programs to meet unique company needs. Clearly the empirical evidence 

shows that companies frequently prevail despite "against" recommendations of proxy 

advisors. 

Regardless, the decisions of directors of U.S. companies are broadly and robustly 

protected under the business judgment rule. As a result, assuming directors acted in 

good faith and as a reasonable person would have acted, shareowners cannot hold the 

board liable for its decisions. 

And in the context of advisory votes-such as non-binding shareowner proposals and 

say-on-pay proposals-directors are under no obligation to act as recommended by 

proxy advisors or approved by shareowners. Certainly a board may face certain 

consequences-such as a "vote no" campaign against directors or possibly a proxy 

contest-depending on how shareowners evaluate the board's response. However, that 

potential outcome is a vital part of checks and balances in the U.S. corporate 

governance model. 

16 Christopher Condon & Sree Vidya Bhaktavatsalam, Fink Leverages BlackRock's $3.5 Trillion in 

Shareholder Push, Bloomberg, Jan. 19,2012. 

12 
389 


81762.352

CII looks forward to continuing to work cooperatively with the Subcommittee, the SEC, the proxy 

advisory firms and other interested parties in addressing the issues raised by this hearing. Our 

goal is to ensure that the issues identified are addressed in a thoughtful manner that best 

serves the needs of long-term investors and the U.S. capital markets. 

Thank you Mr. Chairman and Ranking Member Maloney for providing CII the opportunity to 

submit this statement. 

13 
390 


81762.353

Voting Members 

AFL-CIO 

AFSCME 

Alameda County Employees' Retirement 

Association 

Allstate Corporation 

American Express Company 

American Federation of Teachers 

Pension Plan 

Amgen 

Arkansas Public Employees Retirement 

System 

Assurant Pension Plan 

BP America Master Trust for Employee 

Pension Plans 

Bricklayers & Trowel Trades 

International Pension Fund 

Building Trades United Pension Trust 

Fund - Milwaukee and Vicinity 

California Public Employees' Retirement 

System 

California State Teachers' Retirement 

System 

Campbells Soup 

Casey Family Programs 

Central Laborers' Pension Fund 

Central Pension Fund of the 

International Union of Operating 

Engineers 

CERES 

Chevron Master Pension Trust 

Coca-Cola Retirement Plan 

Colgate-Palmolive Employees' 

Retirement Income Plan 

Communications Workers of America 

Connecticut Retirement Plans and Trust 

Funds 

Contra Costa County Employees' 

Retirement Association 

Danaher Retirement & Savings Plan 

Page 1 of 5 

ATTACHMENT 

Delaware Public Employees' Retirement 

System 

District of Columbia Retirement Board 

Eastern Illinois University Foundation 

Edison International 

Educational Employees' Supplementary 

Retirement System of Fairfax County 

EMC 

Employees' Retirement Fund of the City 

of Dallas 

Employees Retirement System of 

Rhode Island 

Employees Retirement System of Texas 

Fed Ex 

Fire & Police Pension Association of 

Colorado 

Florida State Board of Administration 

Forest Laboratories 

Gap 

General Board of Pension and Health 

Benefits of the United Methodist 

Church 

General Mills 

Hartford Municipal Employees 

Retirement Fund 

Hess Corporation 

lAM National Pension Fund 

Illinois State Board of Investment 

International Brotherhood of Electrical 

Workers' Pension Benefit Fund 

Iowa Public Employees' Retirement 

System 

IUE-CWA Pension Fund 

Jacksonville Police & Fire Pension Fund 

JetBlue Airways Corporation Retirement 

Plan 

Johnson & Johnson 

Laborers National Pension Fund 

LifePoint Hospitals Retirement Plan 

Limited Brands 
391 


81762.354

LlUNA Staff and Affiliates Pension Fund 

Los Angeles City Employees' 

Retirement System 

Los Angeles County Employees 

Retirement Association 

Maine Public Employees Retirement 

System 

Marin County Employees' Retirement 

Association 

Massachusetts Laborers' Health and 

Welfare Fund 

Massachusetts Pension ReseNes 

Investment Management Board 

McDonald's Profit Sharing & Savings 

Plan 

Merck 

Microsoft Corporation Savings Plus 

401(k) Plan 

Milwaukee County Employees 

Retirement System 

Milwaukee Employees' Retirement 

System 

Minnesota State Board of Investment 

Missouri Public School & Public 

Education Employee Retirement 

Systems 

Missouri State Employees' Retirement 

System 

Montgomery County Employees' 

Retirement System 

Municipal Employees' Retirement 

System of Michigan 

Nathan Cummings Foundation 

National Education Association 

Employee Retirement Plan 

Navy-Marine Corps Relief Society 

New Hampshire Retirement System 

New Jersey Division of Investment 

New York City Employees' Retirement 

System 

Page 2 of 5 

New York City Pension Funds 

New York State Common Retirement 

Fund 

New York State Teachers' Retirement 

System 

North Carolina Retirement Systems 

Ohio Police & Fire Pension Fund 

Ohio Public Employees Retirement 

System 

Orange County Employees Retirement 

System 

Pennsylvania Public School Employees' 

Retirement System 

Pennsylvania State Employees' 

Retirement System 

PepsiCo US Pension Plan 

Pfizer Retirement Annuity Plan 

Plumbers & Pipefitters National Pension 

Fund 

Portico Benefit SeNices 

Prudential Employee Savings Plan 

Public Employee Retirement System of 

Idaho 

Public Employees' Retirement 

Association of Colorado 

Retirement Systems of the City of 

Detroit 

Sacramento County Employees' 

Retirement System 

San Francisco City and County 

Employees' Retirement System 

Santa Barbara County Employees' 

Retirement System 

School Employees Retirement System 

of Ohio 

Sealed Air Corporation Retirement 

Plans 

Seattle City Employees' Retirement 

System 
392 


81762.355

SEIU Affiliates' Supplemental 

Retirement Savings Plan 

SEIU Pension Fund 

Sheet Metal Workers' National Pension 

Fund 

Sonoma County Employees Retirement 

Association 

State of Wisconsin Investment Board 

State Retirement and Pension System 

of Maryland 

State Teachers Retirement System of 

Ohio 

State Universities Retirement System of 

Illinois 

Target 

Teamster Affiliates Pension Plan 

Texas Municipal Retirement System 

UAW Retiree Medical Benefits Trust 

UAW Staff Retirement Income Plan 

Union Labor Life Insurance Company 

United Brotherhood of Carpenters, Local 

Unions & Councils Pension Fund 

United Food and Commercial Workers 

International Union Staff Trust Fund 

United States Steel and Carnegie 

Pension Fund 

United Health Group 

Vermont Pension Investment Committee 

Walt Disney 401 (k) Pension Plan 

Washington State Investment Board 

West Virginia Investment Management 

Board 

Page 3 of 5 
393 


81762.356

Non-Voting Members 

Aberdeen Asset Management 

Acadian Asset Management 

AllianceBernstein 

AlphaMetrix 

Amalgamated Bank LongView Funds 

Andre Baladi & Associates 

Angelo, Gordon 

APG Asset Management 

AST Phoenix Advisors 

Australian Council of Super Investors 

AXA Investment Managers 

Bain Capital 

Baring Asset Management 

Berman DeValerio 

Bernstein Liebhard 

Bernstein, Litowitz, Berger & 

Grossmann 

BlackRock 

Blue Harbour Group 

Broadridge Financial Solutions 

CamberView Partners 

Canada Pension Plan Investment Board 

Canadian Coalition for Good 

Governance 

Capital Group Companies 

Capri Capital Partners 

Cartica Capital 

Center for Audit Quality 

Cevian Capital 

Cohen Milstein Sellers & Toll 

Concinnity Advisors 

Credit Suisse Asset Management 

D.F. King 

Deloitte & Touche 

Egan-Jones Rating Company 

EnTrust Securities 

Entwistle & Cappucci 

Ernst & Young 

F&C Asset Management 

Page 4 of 5 

Farient Advisors 

Future Fund Management Agency 

GAM 

Georgeson 

Girard Gibbs 

Glass Lewis 

Global Governance Consulting 

GMI 

Goldman Sachs Asset Management 

Goldman Sachs Investor Relations 

Governance for Owners 

Grais & Ellsworth 

Grant & Eisenhofer 

Grant Thornton 

Grosvenor Capital Management 

Guggenheim Investments 

Hagens Berman Sobol Shapiro 

Hermes Equity Ownership Services 

Limited 

Hewitt EnnisKnupp 

Holland Capital Management 

Ichigo Asset Management 

ING Investment Management 

Innisfree M & A 

Investec Asset Management 

IR Japan 

ISS 

J.P. Morgan 

Kaplan Fox & Kilsheimer 

Kessler Topaz Meltzer & Check 

Knight Vinke Asset Management 

KPMG 

Kroll Bond Rating Agency 

Labaton Sucharow 

Landmark Partners 

Landon Butler 

Lawndale Capital Management 

Lazard Asset Management 

Legal & General Investment 

Management 
394 


81762.357

Lieff, Cabraser, Heimann & Bernstein 

Loomis, Sayles 

MacKenzie Partners 

Marco Consulting Group 

Mesirow Financial 

MFS Investment Management 

Milberg 

MN Services 

Morrow 

Motley Rice 

Nestle SA 

Neuberger Berman 

New Mountain Capital Group 

Norges Bank 

Occidental Petroleum 

Ontario Pension Board 

Ontario Teachers' Pension Plan Board 

Pegasus Capital Advisors 

Pension Consulting Alliance 

Pensions & Investment Research 

Consultants 

Pershing Square Capital Management 

PGGM Investments 

Piedmont Investment Advisors 

Pomerantz Grossman Hufford 

Dahlstrom & Gross 

PRI Association 

PricewaterhouseCoopers 

Progress Investment Management 

Prudential Investment Management 

Pyramis Global Advisors 

Quantitative Management Associates 

Railway Pension Trustee Company 

Red Mountain Capital Partners 

Reinhart Boerner Van Deuren 

Relational Investors 

Robbins Geller Rudman & Dowd 

RobecoSAM 

Robins, Kaplan, Miller & Ciresi 

Rock Creek Group 

Page 5 of 5 

Spector, Roseman, Kodroff & Willis 

Standard & Poor's 

Standard Life Investments 

State Street Corporation 

State Street Global Advisors 

Stone Harbor Investment Partners 

Sumitomo Mitsui Trust Bank Limited 

T. Rowe Price 

testtimber 

testtimber1234334 

The Yucaipa Companies 

TIAA-CREF 

Top Tier Capital Partners 

TorreyCove Capital Partners 

Trevisan & Associati 

Trian Fund Management 

UBS Global Asset Management 

(Americas) 

Universities Superannuation Scheme 

Virginia Retirement System 

Weil, Gotshal & Manges 

Wolf Haldenstein Adler Freeman & Herz 

XT Capital Partners 
395 


81762.358

Examining the Market Power and 

Impact of Proxy Advisory Firms 

United States House of Representatives 

Committee on Financial Services 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Statement of 

Anne Simpson 

Senior Portfolio Manager, Investments 

Director of Global Governance 

California Public Employees' Retirement System 

June 5, 2013 

Chairman Garrett, Ranking Member Maloney, and Members of the Committee, on behalf of the 

California Public Employees' Retirement System (CaIPERS), we thank you for convening this 

hearing. CalPERS is pleased to submit testimony for the record to discuss our proxy voting and 

engagement efforts. 

Some Background on CalPERS 

CalPERS is the largest public pension fund in the United States with approximately $266 billion 

in global assets and equity holdings in over 9,000 companies. CalPERS pays out over $14 

billion annually in retirement benefits to more than 1.6 million public employees, retirees, their 

families and beneficiaries. This is not only an important source of income for those individuals; it 

also provides a positive economic multiplier to the local economy.' We fully understand the 

virtuous circle between savings, investment and economic growth. That is at the heart of the 

CalPERS agenda. 

As a significant institutional investor with a long-term time horizon, CalPERS fundamentally 

relies upon the integrity and efficiency of the capital markets. For every dollar that we pay in 

benefits to our members, 64 cents are generated by investment returns. The financial crisis hit 

us hard with $70 billion wiped from CalPERS assets. While we are pleased that we have been 

able to recover these losses over the last several years, we simply cannot afford another 

decline of that magnitude and there is still much to be done to bring about smart regulation. 

In our view, smart regulation should be structured as follows: 

First, regulation needs to be complete and coordinated. Innovation in financial markets has led 

to the development of new financial instruments and pools. Regulation needs to keep pace with 

financial innovation and the attendant risks in order to be relevant. For example, we believe it is 

, See "The Economic Impacts of CalPERS Pension Payments in 2010", Dr. Robert Fountain, Regional 

Economic Consultants, (July 2011). ("Every California County benefits from CalPERS retirement 

payments. In larger urban counties impact is greatest on the total dollar amount of gross regional product. 

In smaller, rural counties the percentage increase in the gross regional product is greatest. CalPERS 

payments have a positive impact on jobs throughout the state and in 17 counties they supported more 

than one percent of the total jobs in their communities. ") 
396 


81762.359

imperative that Title VII of Dodd-Frank be implemented meaningfully and comprehensively with 

an eye toward investor protection and transparency. 

Second, regulation needs to allow market players to exercise their proper role and 

responsibilities. Capitalism was designed to allow the providers of finance a market role in 

allocating investment, and then holding boards accountable for their stewardship of those funds. 

This is why shareowner rights are vital to the functioning of markets, including the ability of 

investors to propose candidates to boards of directors (known in short as 'proxy access') and to 

remove directors who fail. 

Third, regulation needs to ensure transparency, so that markets can play their vital role in 

pricing risk. Timely, relevant and reliable information is the currency of risk management Those 

agencies which have a role in channeling that information need to be fit for that purpose. (Credit 

ratings agencies were found wanting in this regard.) 

Fourth, regulation needs to address conflicts of interest and perverse incentives which can 

undermine the market's ability to allocate capital effectively. (Short term, risk-free compensation 

for executives has fueled poor decision taking, as one of example of this). 

Fifth, regulation needs to ensure it does not prevent institutional investors from financing 

legitimate strategies, and taking advantage of new opportunities. Regulation is not there to 

prevent risk taking, it is there to ensure that risks are disclosed, and can be managed. 

Finally, regulation needs to be proportionate. For CaIPERS, we balance the additional costs that 

are required with the potential for catastrophic losses. To those who question whether we can 

afford to invest in smart regulation, we reply, how can we afford not to? The financial crisis dealt 

a crippling blow to many investors, and the underlying sub-prime mortgage scandal triggered 

widespread loss for ordinary people throughout the country. The devastating impact on the real 

economy is still with us despite the recovery of markets. The costs of regulation need to be 

weighed against this loss or recognize were we are to improve such. 

We see smart regulation as an investment in safety and soundness of financial markets which 

generate the vast bulk of the returns to our fund. Smart regulation is an investment in the 

effective functioning of capital markets, which is critical not just to our fund, but to the 

continuing recovery of the wider economy. 

Global Governance 

The CalPERS Global Governance Program has evolved over time. In the beginning, CalPERS 

generally reacted to the anti-takeover actions of corporate managers that undermined the ability 

of shareowners of the corporate entity - to ensure accountability and fair play. Later the agenda 

broadened to a wider array of issues which are important to shareowners. CalPERS learned a 

great deal about how to develop dialogue - how to influence corporate managers, what issues 

were likely to elicit fellow shareowner support, and where the traditional modes of 

shareowner/corporation communication were at odds with good governance and performance. 

CalPERS turned its focus toward companies with poor financial performance. By centering its 

attention and resources in this way, CalPERS could demonstrate very specific and tangible 

results on the value of corporate governance. 

Full Text- Page 1 
397 


81762.360

What have we learned over the years? We have learned that (a) company managers want to 

perform well, in both an absolute sense and as compared to their peers; (b) company managers 

want to adopt long-term strategies and vision, but often do not feel that their shareowners are 

patient enough; and (c) companies - governed under a structure of full accountability will have 

a foundation to underpin their sustained, long-term performance. 

We have also learned, that accountable corporate governance means the difference between 

wallowing for long periods in the depths of the performance cycle, and responding quickly to 

correct the corporate course. And, in order to encourage companies to make necessary course 

corrections, we believe shareowners must engage in constructive dialogue with the companies 

they own. CalPERS regularly meets with corporate directors and officers to discuss corporate 

strategy and the alignment of interest. 

CalPERS Global Principles of Accountable Corporate Governance 

In order to advance good governance, CalPERS has developed and annually updates its Global 

Principles of Accountable Corporate Governance ("CaIPERS Principles,,).2 CalPERS Principles 

create the framework by which CalPERS executes its proxy voting responsibilities. In addition, 

the Principles provide a foundation for supporting the System's corporate engagement and 

governance initiatives to achieve long-term sustainable risk adjusted investment returns. We 

also require our external managers to follow these guidelines. 

The execution of proxies and voting instructions is an important mechanism by which 

shareowners can influence a company's operations and corporate governance. It is therefore 

important for shareowners to exercise their right to participate in the voting and make their 

decisions based on a full understanding of the information and legal documentation presented 

to them. 

To be clear, CalPERS does not rely on recommendations by any proxy advisory company; to 

the contrary, CalPERS instead expects proxy advisors to consider governance principles, such 

as CalPERS Principles, in formulating proxy vote recommendations. These firms carry out 

useful research and analysis, but for us the source and main point of contact is the company. 

CalPERS will vote in favor of or "For", an individual or slate of director nominees up for election 

that the System believes will effectively oversee CalPERS interests as a shareowner consistent 

with the CalPERS Principles. 

However, CalPERS will withhold its vote from or vote "Against" an individual or slate of director 

nominees at companies that do not effectively oversee CalPERS interests as a shareowner 

consistent with CalPERS Principles. CalPERS will also withhold its vote in limited circumstances 

where a company has consistently demonstrated long-term economic underperformance. 

CalPERS Principles have four sections - Core, Domestic, International, and Emerging Markets 

Principles. Adopting the Principles in its entirety may not be appropriate for every company in 

the global capital marketplace due to differing developmental stages, competitive environment, 

regulatory or legal constraints. However, CalPERS does believe the criteria contained in Core 

Principles can be adopted by companies across all markets from developed to emerging - in 

2 See "Global Principles of Accountable Corporate Governance" as amended Nov. 14,2011. 

http://'MVW.calpers-governance.org/docs-sof/principles/2011-11-14-global-principles-of -accountable-corpgov.pdf 

Full Text - Page 2 
398 


81762.361

order to establish the foundation for achieving long-term sustainable investment returns through 

accountable corporate governance structures. 

CalPERS Core Principles 

CalPERS believes the following Core Principles should be adopted by companies in all markets 

- from developed to emerging - in order to establish the foundation for achieving long-term 

sustainable investment returns through accountable corporate governance structures. 

1. Optimizing Shareowner Return: Corporate governance practices should focus the 

board's attention on optimizing the company's operating performance, profitability and 

returns to shareowners. 

2. Accountability: Directors should be accountable to shareowners and management 

accountable to directors. To ensure this accountability, directors must be accessible to 

shareowner inquiry concerning their key decisions affecting the company's strategic 

direction. 

3. Transparency: Operating, financial, and governance information about companies must 

be readily transparent to permit accurate market comparisons; this includes disclosure 

and transparency of objective globally accepted minimum accounting standards, such as 

the International Financial Reporting Standards ("IFRS"). 

4. One-share/One-vote: All investors must be treated equitably and upon the principle of 

one-share/one-vote. 

5. Proxy Materials: Proxy materials should be written in a manner designed to provide 

shareowners with the information necessary to make informed voting decisions. 

Similarly, proxy materials should be distributed in a manner designed to encourage 

shareowner participation. All shareowner votes, whether cast in person or by proxy, 

should be formally counted with vote outcomes formally announced. 

6. Code of Best Practices: Each capital market in which shares are issued and traded 

should adopt its own Code of Best Practices to promote transparency of information, 

prevention of harmful labor practices, investor protection, and corporate social 

responsibility. Where such a code is adopted, companies should disclose to their 

shareowners whether they are in compliance. 

7. Long-term Vision: Corporate directors and management should have a long-term 

strategic vision that, at its core, emphasizes sustained shareowner value. In turn, 

despite differing investment strategies and tactics, shareowners should encourage 

corporate management to resist short-term behavior by supporting and rewarding longterm superior retums. 

8. Access to Director Nominations: Shareowners should have effective access to the 

director nomination process. 

Proxy Voting, 2012 Say on Pay 

An example of the positive impact of proxy voting is "Say on Pay". Following the enactment of 

the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), US 

Full Text - Page 3 
399 


81762.362

companies began holding a non-binding vote on executive compensation ("Say on Pay vote") at 

least once every three years. 

CalPERS believes the use of the Say on Pay votes can have the following positive desired 

effects: 

Improved communications between shareowners and the company 

Pay-for-performance practices that better align the interests of executives and 

shareowners through enhanced transparency 

An increased focus on individual company circumstances and sustainable strategic 

goals in the development and evaluation of executive compensation plans 

Improved accountability to shareowners by ensuring corporate board of directors reexamine and act accordingly in cases where compensation packages may be excessive 

or where executives have failed to produce value for shareowners. 

In 2012, CalPERS voted "AGAINST' 239 of the total 2,439 US Say on Pay proposals. In other 

words, CalPERS voted "FOR" more than 90% of US compensation proposals. CalPERS has 

engaged companies to convey outstanding concerns surrounding pay practices, and to date 

close to half the companies have made positive changes and we have subsequently voted in 

favor. 

In making its decisions on Say on Pay votes, consistent with CalPERS Principles, the following 

elements are reviewed and contribute to "AGAINST' votes: 

Concerns surrounding pay for performance discipline 

Severance/Change in Control Arrangements (i.e. Singe Triggers and Tax Gross-ups) 

Vesting of equity awards over a term of less than three years 

Compensation design Incentive Plans that allow repricing of stock options without 

shareowner approval, evergreen provisions, or reload stock options. 

Incomplete disclosures surrounding compensation policy and design (i.e. how pay is 

determined and disclosure of metrics and weights). 

CalPERS also considers sustainability objectives and disclosures as they relate to executive 

compensation. We believe executive compensation plans should be designed to support 

sustain ability performance objectives with specific emphasis on risk management, environment, 

health, and safety standards which are relevant to the company's long-term performance.' 

"CaIPERS Effect" on Targeted Company Share Price 

Since 1987, CalPERS has annually identified companies to engage on governance issues' with 

the goal of realigning the interests of companies and shareowners. To measure the relative 

success of engagement over time, CalPERS has commissioned Wilshire Associates to 

monetize the program and asses performance results. Wilshire monitors the program and 

reports annually on the "CaIPERS Effect"S . 

3 See "Principles and Proxy Voting 2012 CalPERS Say on Pay January 2012-December 2012", 

http://www.calpers.ca.gov/eip-docs/about/committee-meetings/agendasiinvesV201302/item09a-03.pdf 

4 This initiative is the Focus List program. Since 2011 engagement has been confidential. 

5 See "Update to The 'CaIPERS Effect' on Target Company Share Price," May 3, 2012 

http://www.calpers.ca.gov/eip-docslaboutlboard-cal-agenda/agendaslinvestl20 1211Iitem09a-03. pdf (at p. 

4) 

Full Text- Page 4 
400 


81762.363

The latest report analyzed stock performance in those 169 companies from the 1999 

engagement process through the 2009 engagement process and found: 

For the three years prior to the "initiative date," the engaged companies produced 

returns that averaged 38.74% below the Russell 1000 Index on a cumulative basis, and 

25.40% below the respective Russell 1 000 indices. For the five years after the "initiative 

date," the average engaged companies produced excess returns of 17.08% above the 

Russell 1000 Index and 13.83% above the respective Russell 1000 sector indices on a 

cumulative basis. 

Recent CalPERS Activity Regarding jp Morgan 

CalPERS has been actively engaged on the issue of strengthening governance, particularly 

board oversight, at jp Morgan. This included supporting a shareholder proposal (calling for jp 

Morgan to separate the roles of the board chair and CEO) and voting against members of the 

risk committee who we consider do not have the necessary experience in banking to provide 

effective oversight. This is consistent with CalPERS Principles regarding the "Role of the 

Chair"6 and past proxy voting'" 

In articulating the role of the chair, CalPERS Principles provide: 

The chair has the crucial function of setting the right context in terms of board agenda, 

the provision of information to directors, and open boardroom discussions, to enable the 

directors to generate the effective board debate and discussion and to provide the 

constructive challenge which the company needs. The chair should work to create and 

maintain the culture of openness and constructive challenge which allows a diversity of 

views to be expressed. 

This role will be most effectively carried out where the chair of the board is neither the 

CEO nor a former CEO. Furthermore, the chair should be independent on the date of 

appointment as chair and should not participate in executive remuneration plans. If the 

chair is not independent, the company should adopt an appropriate structure to mitigate 

the problems arising from this. Where the chair is not independent, the company should 

explain the reasons why this leadership structure is appropriate, and keep the structure 

under review. 

The chair should be available to shareholders for dialogue on key matters of the 

company's governance and where shareholders have particular concerns. Such 

meetings may need to be held with the deputy chair or lead independent director either 

as an alternative or additionally. All board members should make themselves available 

for meetings with shareholders when an appropriate request is made. 

The losses suffered due to the "London Whale" matter have put renewed focus on the need for 

Board renewal, independent and expert oversight. As a result, CalPERS opposed the reappointment of three board members who sat on the risk committee. We concluded that each 

of the nominees lacked the banking experience necessary to properly oversee the risk 

management system for a bank the size of jp Morgan. 

6 Supra, CalPERS Principles, Item 2.5 

7 CalPERS supported a similar resolution to split the roles of the board chair and CEO in 2012. 

Full Text - Page 5 
401 


81762.364

Conclusions 

As discussed above, CalPERS is deeply committed to corporate engagement that helps align 

corporate interests with those of shareowners. As the providers of capital, we expect boards to 

be responsive to reasonable governance requests, such as compensation programs that reward 

long-term performance, independent board chairs and competent board members. We believe 

complaints about the role of proxy advisory firms from companies that resist constructive 

engagement with shareowners tends to distract from legitimate concerns about corporate 

governance. 

Full Text - Page 6 
402 


81762.365

Written Statement of 

Katherine H. Rabin 

Chief Executive Officer 

Glass, lewis & Co. 

June 12, 2013 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

United States House of Representatives 

"Examining the Market Power and Impact of Proxy Advisory firms" 

liP 

ActiveUS 11120l039v.l 
403 


81762.366

!\c;t!veUS 

Chairman Garrott, Ranking Member Maloney, and Members of the Capital 

Markets and Government Sponsored Enterprises Subcommittee: 

Founded in 2003, Glass Lewis is a leading independent governance services firm that 

provides proxy voting research, recommendations and custom research and voting services 

to more than 1,000 clients from around the world. While, for the most part, institutional 

jnvestor clients use Glass Lewis' research to help them make proxy voting decisions, they 

also use Glass Lewis research when engagjng with companies before and after shareholder 

meetings. Through Glass Lewis' Web-based vote management system, ViewPoint, Glass 

Lewis also provides institutional investor clients with the means to receive, reconcile and 

vote ballots according to custom voting guidelines 

disclose their proxy votes. 

record-keep, audit report and 

In addition to providing services to institutional investors, Glass Lewis se!ls research reports. 

to the advisors of public companies, such as law firms, consultants and proxy solicitors. 

Corporate issuers can acquire research reports on their companjes directly from Glass Lewis 

or via Equiiar, a provider of executive cornpensation data. 

AI! clients of all types get access to Glass lewis research at the same time, upon publicatioo< 

Glass Lewis does nQ.l provide consulting services to issuers, nor does it provide consulting to 

shareholders regarding how to gain support from other shareholders for their proposals or 

dissident nominees in a proxy contest. 

Based in San Francisco1 Californlal Glass Lewis' 300-person team provides research and 

voting services to investors that collectively manage US $15 trillion from branches and 

subsidiaries in the United States, Europe and Australia. 

21" 
404 


81762.367

Background 

Glass lewis' clients range In size from investors with few rniHion dollars in assets under 

management (N AUMN) to those with several trillion dollars US in AUIV1, These clients seek 

advice on as few as 20 companies a year in a single market to several thousand equities 

spanning the globe. It should b(: noted, however, that the larger institutions comprise the 

majority of assets under ma.nagement represented by C;!ass Lewis' clients Jnd, according to 

the Conference Board 2010 Institutional Investor Heport, institutional Investors own over 

half of all equities in the US. Further, the 25 largest institutional investors control, on 

average, more than half of all shares of the largest US companies. ' 

!n Glass Lewis' experience, among institutional Investors of an types (pension funds, mutual 

funds, asset managers and hedge funds), parHculady in North America., Europe and AsiaPacific, the propensity for robust voting and engagement programs has increased 

dramatically over the past decade. 

This trend is not particular to thDse with actIvist or active-investing strategies, Moreover, 

investors of all types and strategies are increasingly tapping their proxy advisor ("PAN) for 

customized research i:md voting services, Glass Lewis supports not only the implementation 

of market-specific custom policies but increasingly supporting client requirements for 

issue-specific policies that are nuanced to address 5ector-, industry- or security-specific 

guidelines. The trend toward engagement, which has been widespread in Europe, the UK 

and Australia for many years, is also expanding rapidly In North America. Many Glass Lewis 

clients across all investor types are now engaging with u.s, companies directly or in 

collaboration with other investors, 

Given the expertise, relationships and investment of time and resources required to 

constructively engage with issuers, especially for investors with global investments who 

want to exercise their ownership rights across all holdings, it is in the best interest of the 

investors' clients and their beneficiaries for investors to make use of the services offered by 

1 The 2010 InstitutiDn,,! Investment Report: Trends in Asset Allocation and Portfolio Composition 29-42, rhe 

Conference Board (Nov. 2010) 

3 I f' 

ActivetiS :J 11701039\f.l 
405 


81762.368

PAs to complement their own research. PAs ultimately help clients manage voting 

responsibi!1ties in an accurflte, timely and efficient manneL 

Statement Highlights 

Glass lewis does not apply a one-size-fits-all approach to the analysis of proxies. 

Gbss Lewis believes each company should be evaluJted based on own unique facts 

and circumstances, including performance, size, maturity, governance structure, 

responsiveness to shareholders, domicHe and stock exchange listing. 

Glass lewis eliminates, reduces and discloses - proactively, explicitly and 

comprehensively - potentia! conflicts, to the greatest extent possible. 

Harvey Pitt's spoken testimony on behalf of the US Chamber of Commerce featured 

significant factual errors regarding Glass LeWIS' conflict management practices. Contrary to 

Me. Pitt's statements, Glass Lewis did, in fact, specifically disclose the potential conflict 

related to Glass Lewis' ownership by the Ontario Teachers' Pension Plan rOTPP") on the 

cover of its analysis of the 2012 Canadian Pacific Railway meeting. Mr. Pitt also incorrectly 

stated that Glass Lewis recommended in the same way that OTPP voted on this meeting, 

which it did not; Glass Lewis recommended voting in favor of seven company nominated 

directors, which OTPP voted against. Further, Glass Lewis has a robust, publicly-disclosed 

conflicts polley, contrary to Mr. Pitt's claim that Glass LeWIS has no interest in developing a 

standard on conf!ict.s. Not only does Glass Lewis have such an interest, we have robust, 

transparent policy on conflict elimination, avoidance, management and disclosure, 

Institutional investors are not IlbHncHy" following proxy advisor recommendations. 

Proxy advisors help investors execute their fiduciary responsibilities with respect to proxy 

voting, The majority of Glass Lewis' clients, like the vast majority of the world's leading 

pension funds and asset managers, vote according to their own custom voting policies. The 

vote decisions derived by implementing those policies or may not correspond with 

Glass lewis recommendations. When they do correspond, it may be for different reasons. 

411' 

ActivcLiS 1112:01039v.l 
406 


81762.369

Whether investors elect to follow J PA's recommendations or derive vote decisions based 

on their own poncYI investors retain the right and J.billty to oversee the process and vote 

differently than their policy dictates _. which do quite frequently. 

Existing regulatory frameworks are not appropriate for proxy advisors. 

While Glass lewis would support the adoption of a regulatory framework tailored to the 

unique aspects of the proxy advisor industry, we do not believe registration as an 

investment adviser would be appropriate, given that we do not provide investment advice 

or manage client assets; nor would be effective in addressing the main concerns raised 

the SEC's 2010 "Concept Release on the U's. Proxy System" and in the hearing, 

Furthermore, requiring proxy advisors to comply with regutatlon that is inappropriate for 

their activities could further inhibit competition. The Canadlan Securities Administrators 

reached this same conclusion In their uConsultation Paper 25-401: PotentIa! Rcgu!iJtlon of 

Proxy Advisory Firms" (June 21, 2012). 

An appropriate alternative to regulation is a code of conduct for the PA industry 

that would address the major issues raised by all stakeholders. 

Glass Lewis is actively working with ISS and other global proxy advisors to develop a code of 

conduct for the proxy advisory industry. This initiative is being conducted under the 

auspices of the European Securities and Markets Authority ("ESMA'·) and the direction of an 

independent chairman, The code development process will include public hearings. A code 

is expected to be completed before the 2014 proxy season begins. GLass lewis has said that 

it expects to apply the code to its activities globally. (Appended is Glass Lewis· response to 

the principles for proxy advisors recently announced by ESMA.) 

Research Development 

Glass lewis has an obligation to provide high quality. accurate and timely research to its 

institutional investor clients, based on the analysis of accurate lnformatlon culled from 

public disclosure. 

Glass lewis was founded on the principle that each company should be evaluated based on 

its own unique facts and circumstances, induding performance, size, maturity, governance 

5 I P f t' 

A::;tiveU511120103'kl 
407 


81762.370

structure, responsiveness to shareho!ders .. domicl!e and stock exchange listing, Therefore, 

Glass Lewis has specific policy approaches for each of the 100 countries where it provides 

research on public companies, These pollcies are based in large part on the regulatory and 

market practices of each country, which are monitored and reviewed throughout the year 

by Glass Lewis' Chief Policy Officer, t\ssociate Vice President of Europe;:m and Emerging 

Markets poncy, Vice President of Proxy Research and research directors, 

Glass Lewis applies general prjnciples, including promoting director accountabilitvf fostering 

close alignment of remuneration and performance, and protecting shareholder rights 

across all of these policies while also closely tailoring them to recognize national and 

supranationa! regulations, codes of practice and governance trends, size <lnd development 

stage of companies, etc 

Glass Lewis' Research Advisory Council ('Council') ensures that Glass Lewis' research 

consistently meets the quality standards, objectivity and independence criteria set by Glass 

Lewis' research team leaders, The Council, chaired by Charles A, Bowsher, former 

Comptroller General of the United States, and supported by Robert McCormick, Glass 

Lewis' Chief Policy Officer, includes the following experts in the fields of corporate 

governance, finance, law, management and accounting: Kevin Cameron, co-founder and 

former President of Glass, Lewis & Co,; Jesse Fried, Professor of Law at Harvard Law School; 

Bengt Haliqvist, Founder of the Brazilian institute for Corporate Governance; Stephanie 

LaChance, Vice President, Responsible Investment and COrpOfJte Secretary, PSP 

Investments; David Nierenberg, President of Nierenberg Investment Management 

Company; and Ned Regan, Professor, Baruch College. 

(Glass lewis' guidelines can be accessed via the Glass l{~wis Issuer Engagement Porta! at 

http://www.glasslewis.com/iss u or/ gll ideli n es/.) 

Glass Lewis engages in discussions with clients, public companies and other relevant 

industry participants and observers jn the development and refinement of tts proxy voting 

policies, Recently, in response to feedback from clients and issuers alike, Glass Lewis 

launched an enhanced version of its proprietary pay-for· performance ("P4P") model for US 

companies. A key change to the mode! was the source of peer group information, which 

G I ;; 

Act'veUS 111101m9v.l 
408 


81762.371

had been a major point of contention for public companies. The newly enhanced model 

now features peers derived from company-defined peer groups. 

In developing its individual reports, Glass Lewis relies only upon publicly· available 

information; it will not incorporate into its research information that is not available to 

clients and other shareholders. 

When Glass Lewis analysts require clarifi.cat!on on a particular Issue, they wil! reach out to 

companies but otherwise generally refrain from meeting privately with companies during 

the solicitation period, which begins when the proxy statement is released. Throughout the 

year, however, G!ass lewis hosts "Proxy Talk" conference cans to discuss meeting, 

proposal or issue in depth; these calls are open to public. For example, in the first half 

of 2013 Glass Lewis hosted Proxy Talks to discuss executive compcnsation-relatt~d issues 

with the compensation committee chair of Pitney Bowes and with executives of Johnson & 

Johnson. Glass Lewis also hosted Proxy Talks with three directors of Occidental Petroleum 

to discuss succession planning at the company and held separate Proxy Talk calls with both 

the management/directors and shareholder proponents at the Timken Company to discuss 

a shareholder proposal to split up the company. 

How Investors Select, Use and Manage Tl:1eir i:'r.QZ!.lLAdvisorlil 

G!ass lewis provides institution;)] investor clients with range of governance services, 

including in-depth research on over 20,000 companies, custom policy implementation 

based on client voting guidelines and proxy vote management services (including ballot 

collection, ballot reconciliation and vote execution services) as we!! as variety of vote 

reporting services. 

The selection of:a proxy advisor Involves significant analysis and consideration of the 

advisor's research methodologies, quality of research and technology, experience and 

expertise of the staff, operations capabilities and internal controls. Issues typically covered 

by investors dudng their initial and subsequ(~nt annual due-diligence visits include: voting 

policies, models used in the analy.sis of compensation, rnarket-by-market regulatory 

reviews, research oversight, quality contro!, research personnel, conflict~management 

procedures and error management, among other issues. 

71 p () 

ActiveUS llJ20J039v.l 
409 


81762.372

Most Glass Lewis investor -clients subscribe to both research and vote management 

services, while the rest are research-only clients (Research"only clients use a different proxy 

voting vendor to receive, track and subrnit baHots and typically buy research from mUltiple 

providers.) The majority of Glass lewis' investor clients .... which include the majority of the 

world's largest public pension funds, asset managers and mutual funds vote according to 

d custom policy or via a custom process for reaching vote decisions, in line with what 

becoming the standard practice in the market. (See the appended list featuring links to the 

governance procedures and voting policies althe world's largest investors.) According to 

the 2012 study by Tapestry Networks and the IRRC Institute, PA guidelines and 

rccommend<ltions are used by investors In different ways. Most respondents to the study 

said they employ custom polidcs and may use Glass Lewis recommendations as point of 

reference. 

WhHe some clients may generally or even consistently vote according to the Glass Lewis 

policy, they regularly review and occasionally override Glass lewis recommendations. 

Further, custom policy clients- who represent the majority of our clients and control a 

supermajority of our clients' assets by dollar value regularly override the 

reCQmmend;ltions triggered by their custom polIcies, as guidelines are designed to 

aHow for review of many issues on a case-by-cJse basis. The overrides vary in frequency 

depending on the client and its approach to the relevant issue. 

At 2013 meetings (through May 31, 2013). tiients voting according to the Glass 

Lewis policy elected to override the Gl<Jss lewis recommendations on proposals 

related to political contributions 9% of the time. Clients voting according to 

custom policies on this issue overrode their custom recommendations or opted 

to vote on this on a case-by-case basis 20% of the time, 

l Voting Decisions at US Mutual Funds: How Investors Really Use Proxy Advisers, Tap-estry NetworKS and lRRC 

Institute, Robyn Sew and Richard Ficfds (June :W12) 

81 

Act]v('U5 111201039v 1 
410 


81762.373

In the case of proposals calling for the separation of Chairman and CEO at US 

companies, dif:nts voting according to the G!ass LewIs policy overrode the G!ass 

Lewis recommendation 7% of the time, Clients that vote according to a custom 

policy on this issue overrode their custom recommendations or opted to review 

and vote on a case ·by·'case basis 14% of the time. 

Since the issuance of the SEC concept release on the proxy system, mneh of the debate 

around PAs has centered on the perceived jnfluence of their voting advice, based on the 

belief that institutional investors "blindly follow" PA recommendations" Those raising 

concerns about the influence of PAs point to the correlation between f'A advice and vote 

outcomes and the timing afvoting by investors relative to when PAs issue 

recommendations or corrections as evidence of the purported influence. 

The extent to which PAs influence voting outcomes is overstated" Further, <lny purported 

influence is ultimately impossible to empirically measure with a high degree of confidence 

given the inability to determine to what extent, if any, an investor's vote was actually 

influenced by one or more PA's recommendations. 

For nearly all proposals, there are at most three possible vote options: For, 

Ag<linst!Withhold or Abst<lio" Given the limited number of voling options and the myriad 

reasons for arriving at any particular decision, vote outcome that is the same as a PA's 

recommendation cou!d be the result of any of the followjng: 

Investor votes the same way as PA but for different reasons" 

o These reasons not necessarily transparent, as rationales for voting are 

generJ!ly not disclosed by investors even when votes by investors are 

disclosed" 

iL Investor votes the same way as PAfor similar reasons, which investors believe are 

sound and appropriate reasons for their vote decision. 
411 


81762.374

o Investors and PAs often share same views on tOPICS, such J5 favoring 

shareholder approval to adopt anti-takeover provisions. 

o As explained above, Glass Lewis develops its poHdes for evaluating 

governance issues based on a review of the regional and local !aws, 

reguiJtions and governance codes applicable to the companies under 

coverage. Glass Lewis bases its research on publicly-available information. As 

suchl it is likely that Glass Lewis wi!! often recommend the same wayan 

investor votes, for the same reasons even when the investor is voting 

according to a custom policy and not the PA's policy. 

Investor has adopted a PA IS policy toward one or more voting issues and, as such IS 

voting in fine with (1 Pfl '5 recommendations for that issue or those issues, 

o The dedsloll to follow a PA's recommendations does not necessarily 

constitute "blind following" of an advisor's advice. Investors select an advisor 

based on a thorough review of the advisor's policy, methodologies, research 

samples, conflict management poHcics and procedures, as weI! as an 

assessment of the experjence and qualifications of the advisor's. management 

and analysts. In addition to monitoring votes throughout the year, investors 

generally conduct annual due-diligence Visits to review these same issues and 

review any questions or concerns that have arisen since their prevIous vlsjt. 

investors retain the right to review ,:md override Glass Lewis 

recommendations - which they regulady exercise. 

The counter·arguments made by issuers to what is stated here often point to the 

correlation between the timing of the Issuance of PA recommend()tlons and when 

shareholders submit their votes. However, this counter-argument reflects a lack of 

understanding of the custom policy implementation processes at PAs. At the same time 

that Glass Lewis publishes own research, Glass Lewis also implements its clients' custom 

recommendations, prompting the clients to review and., jf necessary, execute their votes. 

Also, depending on clients' vote instructions regarding when to submit their votes and/or 

how dose to meeting date a correction is made to the analysis on which client votes are 

/l..ctiveUS 111201039v.l 
412 


81762.375

based, any re-voting based an both custom and Gloss Lewis policies will happen nearly 

instantly ~- iJS soon as any changes to the research or analysis are published. 

Any research that draws conclUSions about the impact of PA recommendations on the vote 

outcome based on what information is publicly available and the assessment of the timing 

of votes relative to when PAs publish their reports is an exercise in conjecture. 

Proxy research providers, like many companies, may face confHcts in conducting their 

business. In the case of PAs. potential conflicts generally fall into three categories: (il 

business, such as consulting for issuers or selling research reports to asset manager 

divisions of public companies; (1) personal, such as where tln employee, an emp!oyee's 

relatjve or an external advisor to the PA serves on a public company board; or (iii) 

organizational, such as being a public company itself or being owned by an institutional 

investor. 

Glass Lewis believes proxy research providers should eliminate, reduce or disclose conflicts 

to the greatest extent possible. Glass lewis maintains strict policies, reviewed and revised 

annually, governing person()!, business and organizational relationships that may present a 

conflict in independently evaluating companies. The policies, which all employees 

acknowledge receipt of at the beginning of each year, are disclosed on Glass Lewis' public 

website. For a complete copy of G!ass Lewis' Conflict ot Interest Statement, please visit 

Lcl12.;l!www"gla ss 1"-'".'JJ.:;£9D1L.fQ!l11le.Q.Y!.9ls.'iQ::C~LsEbE· 

Glass lewis provides independent research, analysis and proxy voting advice to institutional 

investors, Its voting recommendations are based on G!ass LeWIS' independent 

determination of what would be in the best interests of long-term investors. As result, 

Glass Lewis does 110t enter into business relationships that conflict with its mission of 

serving institutional participants the capital markets wjth objective advice and services. 

However, Glass Lewis recognrzes that some conflicts are unavoidable. In those cases, 

regulatory bodies in many markets have historically required entities, including public 

companies! to provide slgniflcant disclosure about potentia! conflicts. For example, in many 

111 

ActlveUS 11l201039v.J 
413 


81762.376

countries Issuers must disdose fees paid to audit firms for both audit and non-audit work to 

h!ghlight any conflicts. 5jmHarly, companies must disclose certain related-party transactions 

of executives and directors so that investors are able to determine jf those -conflicts 

affected the independence and ultimately the performance of the director. Furthermore, 

regulators, such as the SEC, require companies to disclose certain fees paJd to 

compensation consultants an indication of potentia! conflicts when the consultants 

provide additional services to tht-:: company. 

Research providers should be required to proactively provide robust and specific disclosure 

about their potential conflicts. Only in this way can the users of the research make a 

determination jf the research is tainted by the conflict. 

Since conflicts can arise not just in the provision of services but even in the solicitation of 

them, the cleanest and most effective way to manage conflicts is to eHrninate them where 

possible, Recognizing this, Glass Lewis was founded with the core policy of not providing 

any consulting services to corpofrJte issuers. Glass lewis believes PAs that do provide 

consulting services to companies on whlch they subsequently write research reports should 

disclose the extent of their business relationships proactively, specifically and in detail, as 

should the public companies receiving such consulting. 1n addition, Glass LewIs does not 

consult with investors on how to gain shareholder support for those 'Shareholders' 

initiatives. 

Glass Lewis takes precautions to ensure lts research 1S objective at an times and under an circumst<lnces. As an indirect who!lymowned subsidiary of OTPP, Glass Lewis maintains its 

independence and operates completely separate from OTPP. OTPP is not involved in the 

day-to-day management of Glass Lewis and !S excluded from any involvement in how Glass 

Lewis formulates voting policies and recommendations. The proxy voting <:lnd related 

corporate governance policies of Gtass Lewis enforce that separation from OTPP. 

As part of Glass Lewis' continued commitment to its customers, Glass LewIs' independent 

Research Advisory Council ensures that Glass Lewis' research consistently meets the quality 

standards, objectivity and independence criteria set by Glass Lewis' research team leaders, 

12 I 

A:::tiveU511UD1039v,1 
414 


81762.377

As discussed above, Glass Lewis does not offer consulting servlces tD public corporations or 

directors. Glass Lewis 15 not in the business of anvising pub!1c companies on their 

governance structures or conduct, iJnd does not use Its position as trusted advisor to 

institutional investors to win consulting mandates with issuers, 

In certain instances, Glass Lewls may provide its research reports to investment managers 

that may be affiliated with publicly-held companies_ In such cases, however, Glass Lewis 

disdoses any such relationship on the cover of the relevant research report. Moreover, 

Glass Lewis makes its research reports generally avai!able post~pubiication, 

Furthermore, Glass lewis maintains additional conflict disclosure and avoidance safeguards 

to mitigate potential conflicts_ These apply when: (i) a Glass Lewis employee, or relative of 

an employee of Glass Lewis, or any of its subsidiaries, a member of the CouneO, or a 

member of Glass Lewis' Strategic Committee serves as an executive or director of public 

company; {lj} an investment manager customer IS a public company or a division of a public 

company; (iii) a Glass lewis customer submits shareholder proposal or is a dissident 

shareholder in a proxy contest; (iv) OTPP holds a stake in a company significant enough to 

be subject to public disclosure rules regarding Its ownership in accordance with the local 

market's regulatory requirements; or (v) OTPP discloses its ownership stake in a company, 

through OTPP's published annual report_ 

In each of the instances described above, Glass Lewis makes full, specific and prominent 

disclosure to its customers in the disclosure section of the relevant research report. Just as 

companies bear the burden to disclose potentia! conflicts, Glass Lewis recognizes th<Jt the 

onus should be on the conflicted party to disclose any potential conflicts_ In addition, where 

any employee or relative of an employee an executive or director of a public company, 

that relationship not only disclosed but thot employee plays no role in the analysis or 

voting recommendations of that company. 

Glass Lew!s believes examining the treatment of other conflicts is iHustratlve for 

determining the precedent for successful examples of conflict avoidance and disclosure_ 

One example of an industry where thE:~ current solution was found ineffective is the credit 

ratings indust'Y_ Some credit rating agencies, which in effect sell their ratings to the 

companies they ratel have been found to have altered ratings at the request of issuers. This 

13 I e,l 
415 


81762.378

ability to potentially negotiate better rating creates the opportunity to "game" the 

system. 

On the other hand, the treatment of audit firm conflicts under the Sarb<lne5·0xley Act in 

the United States provides an example of an effective means of limiting conflicts by 

significantly limiting an audit firm's ability to work for both the audit committee and 

company executives., coupled with specific disclosure requirements. 

Glass lewis provides specific, prominent disclosure of all potential conflicts, induding those 

arising from Glass Lewis being owned by OTPP. !n Mr, Pitt's testimony on June 5, he 

claimed that with regard to the vote at the Canadian Pacific Railway proxy contest in 2012, 

G!ass Lewis issued recommendations in its report but did not disclose the conWct other 

than with "vague, generic" !anguage, That was not as there was a prominent, 

specific note on the front page of the report highlighting OTPP', ownership of Glass Lewis. 

This erroneous claim compounds the error made by the US Chamber of Commerce ("the 

Chamber") in its letter to the SEC Chamber indicated that Glass Lewis' decision to 

recommend voting in favor of the dissidents at the Canadian Pacific Hailway meeting, after 

it became public that OTPP was voting for the dissidents, was evidence that Glass Lewis' 

recommendation was desjgned to benefit OfPP's "unique interests" {presumably as 

opposed to the interest of other shareholders who also supported the dissidents, in an 

overwhelming fashion). The Chamber further claimed in the same letter that the Glass 

lewis recommendations and OTPP's vote demonstrated a strong possibility that the 

recommendations and vote were 'Ibeing coordinated in some manner," an outrageous and 

unsubstantiated charge. (Appended to this statement IS the response from Glass Lewis to 

the US Chamber of Commerce's letter to the SEC, 

http://www.centerforcapitalmarkets.com/wp·content!uploads/2010/04/2012,5.30,Glass' 

Lewis,letteHelease.pdf). This baseless charge is further debunked by the fact that while 

G!ass lewis recommended voting in favor of seven management nominees, OTPP voted 

againstthem aiL 

Accuracy, Corrections and Engagement 

Glass Lewis recognizes that clients rely on the informatron and analysis contained in the 

Proxy Paper research reports to help them make informed voting decisions. Therefore, the 

14 I P 

ActiveUS 11.l101D39v.l 
416 


81762.379

firm has developed robust and comprehensive training, oversight and editing processes to 

ensure a high level of accuracy and data integrity in the reports. Another control that 

analysts' authority to publish Proxy Papers, Le. the final step in providing them to dients, is 

limited based on the j')sues covered in the report as weI! the analyst's specialty, seniorjty 

~nd expertise. For example, only senior members of the Mergers & Acquisitions team are 

authorized to publish reports on such financial transactions, 

Prior to publication to clients, all draft reports are reviewed and edited by at least two 

additional senior analysts and managers up to and induding a Oirector of Rc~search, a Vice 

President of Research, the Managing Director of Mergers & Acquisition Analysis and/or the 

Chief Policy Officer. 

Glass Lewis evaluates all concerns induding purported errors raised by corporate issuers 

subject to the Proxy Paper research reports. Issuers can submit queries, requests for 

meetings and notifications of subsequent Wings and additlona! information as well as what 

they perceive to be errors via our Issuer Engagement Portal. When G!ass Lewis is notified of 

a purported error, it immediately reviews the report and, if there is reasonable likelihood 

the report wi!! require revising, removes the report from its published status so no 

additional clients can access rL Howevec often what a corporation indicates js an error is 

ultimately a difference in interpretation or opinion regardjng a cert()ln issue, and therefore 

requires no correction. As of May 31,2013, material errors in Glass leWIS' research 

(brought to our attention by the company, its advisors or through subsequent disclosure) 

that resulted in a change to the Giass lewis recornmendation represented onc~tenth of 1% 

of the items up for vote at US companies analyzed by Glass Lewis. 

In most markets, Glass Lewis publishes its reports well in advance of meeting date; in the 

US an average of three weeks prior to the meeting. This provjdes sufficient time for Glass 

Lewis to receive and respond to notifications of any factual errors. Just as Glass LeWIS 

discloses specific inforrnJtion about conflicts in the disclosure section of reports, the 

exact nature of all report updates and revisions are described, Including changes to 

recommendations, 

When a report is updated to reflect new disclosure or the correction of an error, Glass Lewis 

notifies all clients that have' accessed the report that have ballots in the system for the 

is I P 
417 


81762.380

meeting tied to that report - whether or not the update affected Glass Lewis and/or clients' 

custom recommendations. 

Outside the solicitation and proxy season blackout periods, Glass Lewis open to meeting 

with companies to discuss research policies and methodologies, as we!! perspectives on 

both general topics and issues specific to the company. Indeed, Glass Lewis meets with 

hundreds of public companies each year in person or by phone. Companies can request 

meetings via the Glass Lewis public website at http://www.glasslewis.com/issuer/. 

In accordance with feedback from Glass lewis does not believe it is in the best 

interests of investors to provide previews of PA analysis to the subject companies. ThiS type 

of "consultation" would open Glass lewis up to being lobbied by companies, since 

companies could use this communication opportunity to push for a change in a 

recommendation against management. Furthermore, from a practical perspective, given 

the often tight timeframe between the issuance of the proxy statement and the vote 

deadline, any delay in the distribution of reports to investors would further limit the time 

available for them to review the analysis, discuss in internal meetings (many clients 

maintain proxy committees), engage with companies and make fully informed voting 

decisjons. 

Glass Lewls is currently explorlng how to provide issuers with access to the data used in the 

development of anafysjs~ on a company-by-company basis, for review by companies 

prior to issujng reports. Untl! that time! G!ass Lewis does not Intend to make any of its data 

or research available prior to publication to dients. For more information on Glass Lewis' 

Corporate Engagement Policy, go to: http://www.glas.2.e~wis.comlfor··is~..-.2.1gj95_S.1e_~i2: 

corporate-engagemer::l1:J2Q1lffi· 

Glass l.ewis typically publishes its reports on annual general meetings three weeks prior to 

meeting date. Publishing times may vary depending on the timing of disclosure and the 

types of issues up for vote. Analysis on mergers and acquisitions and other financial 

transactions, for example, !$ generally published closer to met:ttng date. For information on 

how to access individual Glass Lewis reports upon publication, go to "Accessing Glass lewis 

Reports" at http://www.glasslewis.com/issuer/. 

G!ass Lewis maintains a robust employee code of ethics, receipt and understanding of 

which is acknowledged annually by each employee. The code addresses conflicts, 

16 I P 

l'l1201039v,1 
418 


81762.381

confidentiol treatment of client information and trade reporting, among many other 

practices. 

Since the issuance of the SEC proxy system concept release, the Canadian Securities 

Administrators ("CSA") and the European Securities and Markets Authority ("ESMA") has 

each issued similar releases regarding the PA industry. (Appended Zlre Glass Lewis' letter to 

the SEC responding to certain questions raised by the U.S. Chamber of Commerce and our 

response to the CSA's consultation papeL) The CSA's popel' contained an assessment of the 

potential regulatory frameworks considered in their release and determined that (i) PAs 

should not be required to register "advisers;" (ii) the work of PAs does not amount to 

"soliciting" proxies; and (iii) PAs should not be regulated under the fromework 

contemplated tor credit rating agencies. 

Glass Lewis recognizes that different laws and regulations apply in Canada than in the 

United States. However, Glass Lewis believes the (SA's conclusions outlined in its 

"Consultation Paper 25 .. 401: Potential Regulation of Proxy Advisory Firms" (June 21, 2012) 

with respect to the appropriateness of investrnent adviser registration of proxy advisors are 

relevant to the u.s. situation: 

"tn our view, proxy advisory fjnns arc not- in the business of Jdvising in the purchase or sale of 

securities, and therefore, should not be required to register as "advisers" under our securities 

acts. A!though proxy advisory firms provide advice when they make vote recommendations to 

thplr dients regarding proposals put to sharehOlders at shareholders' meetings, this advice is 

most often not directly with respect to an investment in securities or the purchase or sale (If 

securitjes, 

Moreover, the actiVities of proxv advisory firms do not fit within the principJes underlying the 

registration regime since activities have little connection with registration in the 

trJditional sense and are remote from the protection of retail inve5tors~ 

As our objective would be to regulate proxy advisory firms as market participants and 

ncc(1ssari!y to specifically regulate their relationships with dients, the application of the 

principles of registration would pose a challengE', 

17 I P ;, 
419 


81762.382

An additional difficulty is that the registration requirements and the registrant obligations 

under N! 31-103 (National Instrument 31·103 governs registration requirements and 

exemptions for relevant entities in Canada} are not tailored to the business of proxy adviSOry 

firms. 

If we chose to regulate proxy advisory firms as we wDuld have to consider whether 

our current fitness requirements for registered advisers based on the principles of proficiency, 

integrity and solvency are appropriate. Once registered, proxy advisory firms would then be 

subject to our oversight through our complL:mce programme and our enforcement 

function." 

The (SA paper also concluded the following with respect to whether proxy advisor activities 

constitute the "soliciting" of proxies: 

"We do not believe that the activities of proxy advisory firms amount to "'solicitine" proxies 

nor is preparing and se-nding a proxy drcular the proper response to the concerns- rJlsed. Our 

view is supported by the fJet that proxy voting advice is not considered !>oliciting under aur 

existing proxy soJicitation rules, evidenced by the exception to the definition of "sandt". 

Proxy solicitation rules should only apply if the person is actually soHcltinp, proxies. 

Furthermore, if we chose to regulate proxy advisory firms through the proxy solicitation 

requirements in Nl 51-102 (National Instrument 51-102 governs continuous disclosure 

obligations including those rdating: to proxy solicitation for entities in Canada), we would be 

crciJting a regulatory framework for proxy advisors In rule thilt is designed to apply mainly to 

reporting issuers, 

For these reasons, we do not be!leve that 

contained in N! 51-102 IS an appropriat.e 

proxy solicitation regu!<)tory framQwork 

regulatory framework for proxy advisors." 

Glass lewis believes that any binding or quasi-binding regulation of PAs would be 

inappropriate and potentially harmful. The reasons for this vic:w include: 

Investors are fiduciaries that already hold their advisors accountable for the 

quality and accuracy oj the services they provide . .. < The market does work. 

!nstitutional investors have a fiduciary responsibility to vote proxies in a manner that is in 

the best interests of their beneficiartes. has been Glass Lewis' experience, as a provider of 

research, proxy voting and other governance services to nearly hundreds of Investors across 

the globe, that investors take this responsibHity very seriously. 

18 I F 

Activ"US 111/01039v.l 
420 


81762.383

Institutional investors hold PAs accQuntJble for providing objective, accurate and highquality research services that arc developed and delivered in dccordance with client 

instructions. In addition, PAs must meet the requirements set forth by their clients for 

managing and disclosing conflicts of interest. 

If an advisor fails to meet the standards and requirements set forth by the client, that client 

has the option to select another provider, 

PAs are just one participant in a large voting chain, which inc/udes issuers, ballot 

distributors, custodians" 5ub··custodfans and registrarsf among others, 

Research development by PAs is dependent on the activities of several members of the 

voting chain. It would be inappropri"te and potentially harmful to investors if any regulator 

were to mandate quasi-binding or binding instruments without mandating related 

instruments for other participants in the chain, 

• A proliferation of differing binding or quasi··binding regulatorv instruments in 

different jurisdictions would be potentially burdensome for both investors and PAs, 

impacting shareholder rights and creating barriers to entry into the proxy advisory 

industry. 

Glass lewis is working with ISS and other key members of the global proxy advisory industry 

to develop an industry code of conduct that could apply globally and would govern policy 

and research development; conflict management and disclosure; and transparency. 

Information on this code is attached. 

Conclusion 

Glass Lewis welcomes the opportunity to work with the Subcommitt€e "nd other interested 

parties to find the appropriate ways to address issues raised in the hearing that relate to 

the proxy advisory industry in a manner that best serves the needs of long-term investors 

and the US capital markets. Indeed, we look forward to getting feedback from all 

stakeholders on the industry code of conduct currently under development. 

Thank you, Mr. Chairman and Ranking Member Maloney for providing Glass lewis with the 

opportunity to submit this statement. 

19 I r .l g P 

ActiveU5111201039v,1 
421 


81762.384

21 March 2013 

Glass lewis Supports ESMA Principles for Proxy Advisors 

Global proxy advisors are working to develop an industry code of conduct 

Since the 2010 release of the SEC's concept the us proxy system, Glass L<.~wis has been 

adlvely engaged with regulators, investors, issuers and other stakeholders across the globe regarding 

the role of proxy advisors, 

!n responses to three subsequent consultations, issued in 2012 by the European Securities and Markets 

Authority ("[SMA"t Canddian Securities Administrators (,,(SA") and the Corporations and Markets 

Advbory Committee of Australia ("CAMAC"}, Glass Lewis has consistently expressed the view that a 

markc+bClsed solution, in particulJr a ('Ode of best practices developed by proxy adVISors, is the 

appropriate means to address the relevant Issues raised in these consultation<; - namely conflict 

m<:magement, transparency of policies and methodologIes, and engagement, 

Glass Lewis is actively worklng with a group of proxy advisors operating in Eurupe to develop such a 

code, Given that the principles outlined in the ESMA broadly applicable to al! 

markets, it is Glass lewis' intention to llpply the code under deve10pment to activities globaHy, not just 

in Europe, 

Gelow are the ESMA principles for proxy addsors and summaries of Glass lewIs' views on the re!ated 

issues. Mare detailed information on Glass Lewis' views is contained in the Glass Lewis consultation 

paper responses, which arc available at .t'LUp .. ;jL\y'~~gJ_<l.~a~yy:0...:£.9JnL~Q..<.Lu...tE.l~~:k,::,:d~l?!~~:Jel(,3ses/. 

1. Identifying, disclosing and managing conflicts of interest 

Principle: Proxy advisors should seek to avoid conflicts of ,interest with their clients. Where a conffjct 

effectively or potentially arises the proxy advisor should adequatefy disclose this conflict and the steps 

which it has token to mitigate the conflict in order that the client can make a property informed 

assessment of the proxy advisor's advice. 

ESMA Rationale: Considering their important role in voting proxy Jdvisors can, like many 

intermediaries, bE' subject to conflicts of interest. They should therefore identify, disclose and rnanage 

these conflicts to ensure the independence of their advice, ESMA learned from the market consultation 

that market participants arc concerned regarding potential conflicts of interests, in particular about 

circumstances where: 0) the proxy advjsor provldes services both to the investor Clfld to the issuer; and 

(il) where the proxy advisor]s owned by an tnstitutioo<)j lnvl?stor or by a listed company to whom, or 

about whom, the proxy 3dvlsor may be providing adVICe. 
422 


81762.385

Glass lewis Views: Proxy advjsor~ ("PAs"), !ike many companies, may face conflicts in conducting their 

business. In the case of PAs, potential conflicts genera!!y fa!! into three categories: (0 business, such as 

consulting for issuers or sE'Hing reports to asset manager divIsions of public companies; {iiI 

persontll, where an employee, an employee's rdative or an external advisor to the PA SNVes on () public 

company board; or (WI organizational, such as being a pulJlic company itself or being owned by an 

institutionaiinvestor, 

Glass Lewis believes PAs should eliminate, rf:'duce or discime conflicts to the greatest extent possible. 

Glass Lewis maintains strict poricles, reviewed and revised annuaUy, governing persona!, business and 

organizJtiona! relationships that may present a conflict In independently evaluating companies. The 

policies, which all employees acknowledge receipt of at the beginning of €Clch year, are disclosed 0[1 

Glass Lewis' public website, For <l complete copy of Glass Lewis' Conflict of Interest Statement, please 

visit !1ttp:llwww,giass!ewisMJl1i£C:[l1iLi!!lYl..9l2£Lo5ure.olm. 

Since conflicts can arise not just in the provision of services but even in the soJkitatlon of them, the 

cleanest and most effective way to manage 15 to eilminale them where possible. Recognizing 

this, Glass Lewis w('ts founded with the core PQlley of not providing any consulting services to corporate 

issuers. 

Glass lewis takes precautions to ensure is objective all times ilnd under al! circumstances. 

As an indirect wholly-owned subsidiary of Ontario Teachers Pension Plan ("OTPP"), G!<"tss lewis 

niaintalns its independence and op€rates completely separ2lte from OTPP, OTPP is not Involved in the 

d<lY to-day management of Glass Lewis and excluded from any involvemf'nt jn how Glass Lewis 

formulates voting policies and recommendations. 

The proxy voting and related corporate governance policies of Glass lewis enforce that separation from 

OTPP. As part of Glass Lewis' continued commitment to its customers, Gloss Lewis has an independent 

Research Advisory Council ("Coundl··'). The Council ensures that Glass Lewis policies and guidelines 

reflf'ct current and developing trenns, including regulatory changes and practices, and that G!ass 

LeWIS research meets the highest standards of quality, objpctivity and independonce 

Although Glass Lewis is not in the business of ;]dvi5ing public companies on their governance structures 

or conduct, Glass Lewis may provide its reseiJrch reports to investment managers that are affiliated with 

publicly-held companies. In such cases, however, GJass LeWIS discloses with specificity any such 

re!<l:ilonship in the relevant research report, 

Furthermore, Glass Lewis maintains additional conflict disclosure and avoidance safeguards to mitigate 

potentia! conflicts. These apply when: (J) Glass Lewis employee, or relative of an employee of Glass 

lewis, or any of its subsidiaries, member of the Council, a member of Gl(lsS lewis' Strategic 

Committee serves as an eX{>cutive or director of iJ public company; Iii) an investment manJ.r;.N customer 

i5 iJ public compiJny or a division of a public comp;:my; {iii) a G!ass Lewis CUStODlE'f submits;3 shareholder 

Lec 
423 


81762.386

proposal or is a dissident shareholder in a proxy contest; ;:Hld (1v) when Glass LewIs provides coverage on 

a company in which OTPP holds stake signJficant enough to be subject to publk disdosure rules 

regarding its ownershIp in accordance with the local market's regulatory requirements; or Glass lewis 

becomes aware of OTPP's disclosure to the public of its ownership stake in such company, through 

OTPP's published annual report or any other puhlicly <lvJ1!ab!(" information disclosed by OTPP. 

In e<Jch of the instances described above, GI<'lsS Lewis makes full, specific and prominent disclosure to 

customers in the relevant research report. companies bear the burden to disclose potential 

conflicts, GJdss Lewis recognizes th~t the onus should be on the conflicted party to disclose any potentia! 

conflicts. In addition, where any employee or relative of an ernployee <In or director of a 

public company, that relationship not only disclosed but that employee plays no role in the analYSIS 

voting recommendations of that cornpany_ 

2. Fostering transparency to ensure the accuracy and reliability of the advice 

Principle: Proxy advisors shoufd provide investors with [n!orrnaUon on the process they have used in 

making their genera! and speCific recommendations and any limitations or conditions to be taken into 

account on the advice provided so that investors can make appropriate use of the proxy advice. 

ESMA Rationale: Proxy advisors may have systems and controls in plaCE:> that guarantee proper and 

sound advice. These systems and controls may increase the reliability of thE' advice and enlarge 

accuracy. ESMA lp.arned from the market consultation that the market would specifically favour greater 

transparency of these systems ;mo controls, including, but not limited to (i) disclosure of gp.neral voting 

poll des and methodologies, (il) consideration of local market conditions and (iii) providing information 

on engagement with issuers, 

Glass Lewis Views: Glass lewis reports are typically available three weeks prior to meeting date, which 

provides sufficient time for Glass Lewis to receive <'Ind respond notifications of potentia! factuJi 

errors. (Publishing times may vary depending on the timing ot the disclosure and the types of issues up 

for vote, such as mergers and acquJsitions or control contests,) 

ngp~,,-Vi~~_'!LJl!"I,l!,l\','~'WJjll2Y"[i, under "Accessing Glass Lewis Reports." 

available at the same location under "Reporting 

.lust Glass lew];:; dlsrlosf"'; information iJbout potenti<l! conflicts on the front page reports, the 

exact nature of al! report updates and revtsions are described in the reports, induding changes to 

recommendations, When report is updated to reflect new disdosure or the correction of an error, 

Glass Lewis notifies all clients that have accessed the report or that have ballots in the system for the 
424 


81762.387

meeting tied to that report - whether or not the update affected Glass Lewis and/or clients' custom 

recommendations, 

2J. Disclosing general voting policies and methodologies 

Principle: Proxy advisors should, where appropriate in each context, disclose both publicly and to client 

investors the methodology and the nature of the specific information sources they use in making their 

voting recommendations, and how their Iloting policies and guidelines are applied to produce voting 

recommendations. 

ESMA Rationale: To allow all stakeholders, especially investors 3nd to better assess the accuracy 

and reliability of the proxy advisor's services, proxy advisors are expected to be transparent on their 

voting policy ilnd on main characteristics of the methodology they JpplYJ which form the rationale 

their recommendations, This is al50 in line with the overaH message that ESMA received from the 

miJrket consultation for greater transparency, 

activities and processes. 

JppropriJte, by proxy advisors about their 

Glass lewis Views: Glass lewis guidelines available at hl1121/www.gl;)s . .>I€wjs.com/res~. 

addition, information on Glass Lewis' approach to analyzing financial transactions is available at 

b!!f!i,~VI';~RI<!.~'}Y1L<:scrlJlloc~'LJ~!s::l£!~£~!~'l:'2.fjjDslllfl,lH@Q2'l!;!J2:021 Also, information on Glass 

Lewis methodoiogies for eVJluating pay for performance, advisory votes on compensation ("Say on 

Pay") and equity-b3sed compensation ,waiJable at J:1J.!~Y,~'4@251ewi5""Q2!}11~81I;1~r:Lc:QEflpens3tl.Q.!l: 

9.!l;ll.'llliL 

In developing its individual reports, Glas<; lewis only upon publicly-available information; it wiH not 

incorporate into its research information that is not available to clients and other shareholders, When 

Glass Lewis analysts require clarification on p"rticubr they wiil reach out to companies but 

otherwise generally refrain from meeting privately with companies during the solicitation p~riod, which 

begins when the proxy circular is Throughout the year, however, Lewis "Proxy 

Talk" conference ca!1s for investors to discuss a meeting, proposal or issue in depth; depending on the 

topic, these calls may be open public. 

2Ji. Considering local market conditions 

Principle: Proxy advisors should be aware of the local market, legal and regulatory conditions to which 

issuers are subject and disclose wfwther/how these conditions are taken into due account in the proxy 

advisor's advic€< 

ESMA Rationale: Proxy advice gener<:dly is a cross-border artlvlty which requires the awarl?ness of 

different laws, rules and regulations governing issuers' activities in each relevant jurisdiction. Therefore 

proxy adVisors, as ESMA also learned frorH market consultation, are expected to haw: proper 
425 


81762.388

knowledge of the nation;]! and regional context, irre",pective of whether proxy advisors choose to apply 

an internJtlonal benchmark, own preferences/poHcies, 1n forming thpir opinion of 

individual meeting resolutions. Such knowledge ot localjregional conditions is needed in order to 

develop an accurate voting pollcy, and, as a result, <:In ap!1fopriate 

Glass lewis Views: Glass levvis was founded on the principle that each company should be evaluated 

based on its own unique facts and circumstances, including performance, SIZE', maturity, governance 

structure, responsiveness to shareholders and, last but Ira5t, location. Therefore, Glass Lewis has 

policy approaches for each of the eountrie::t where it provides research on public companies. These 

policies Jre based in large part on the regulatory and market practices of each country, which are 

monitored and reviewed throughout the year by Glass lewIs' Chief Poney Officer, Associate Vice 

President of European and Em~rging Markets Policy, Vice President of Proxy Research and research 

directors. G!ass lewis <.lppljes genem! principles, including promoting director dccountClbHity, fostering 

dose Jlignment of remuneration and performance, and prot€'cting "hareholder rights across aU of these 

polides while also clDse!y tailoring them to recognize national and supranational regulations, codes of 

practice and governance trends, and development of complHlles, 

Glass lewis engages in discussions with clients, public companies and other rc!evant industry 

participants and obst:'rvers in the development and refinement of proxy voting policies. In 2012, in 

response to feedback from clients and issuers alike, G!asslewis launched enhanced version of its 

proprietary pay-fQf-periormanc~ ("P4P") model for US companies. f\ key change to the model WJS the 

source of peer group information, which had been a major point of contention for publk companies. 

The newly enhanced model now features peers derived from company-defined peer groups. Glass Lewis 

displays the peers used in analysis dnd identifies any differences between the peer group used in the 

mode! and compJnies' self-selected peer groups. 

2.jii. Providing information on engagement with issuers 

Princ;iple: Proxy advisors should inform investoiS about their dialogue with 

that diafogue. 

and of the nature of 

ESMA Rationai€: Proxy advisors can choose' whether or not to hay!? a dinlogue with Issuers. If they do 

choose to have such a dialogue, it is up to the proxy advisor what should be the tIming, frequency, 

intensity and format for this dialogue, A proxy advisor should disclose to investors whether there 

dialogue between the proxy advisor and an issuer. Where such a dialogue takes place, it should inform 

investors about the nature of the dialogue, which may also include informing of the outcome of 

that dialogue. ESMA learned from the market consultation that some proxy advisors do not conduct 

dialogue with issuers. When there is dialogue, the nature and degree of th<1t diCllogue differs 

signifkantly among proxy advisors, as weB <:IS the level of trarlsp<Jrency on the fJct that dialogue is taking 

place. 
426 


81762.389

Glass lewis Views: Dialogue between investors iJnd companies can be an effecUve means for investors 

and companies to gain (l better underst,lndlng of each othN'S goals and strategies and is theretore to be 

encouraged, This dialogue should be undertaken year-round to develop meanlngful relationships and 

ensure a high level of trust. Glass Lewis often engages in discussions with wmpanles out:;;ide the proxy 

season, but prefers not to have off~the-reCQrd discusstons with companies during the proxy solicitation 

period to ensure the independence of its and advice -- something that highly valued by 

clients - and to avoid receiving Information, including material non-public information, not otherwise 

available to shareho!ders< H has been Glass Lewis' experience that issuers generally try to use 

solicitation-period discussions to lobby for the support of a recommendation or to learn what changes 

Glass Lewis requires in order to "win" Glass lewis support for items up for vote. This is not Zlppropriate, 

given that Glass lewis is not empowered to negotiate on behalf of clients, who often hold different or 

even opposing point.:. of view on certain 

Glass lewis' research professionals Jnalyze pubHc company fil1ngs, specificany proxy statements <:md 

financial statements, as well as multiple exlerna! orlginal research sources to board 

effectiveness and company risk profilr.s. If Glass Lewis analysts require darification on particuhr issue, 

they will reach out to companies, 

As previously stated, throughout the year and very frequently during the proxy season, Glass lewis hosts 

"Proxy Talk" conference calls with issuers and shareholders, as relevant, to discuss meeting, propOsal 

or issue In depth. Glass lewis' ciipnts and other shZlreho!ders are invited to listen to the call and submit 

questions to the speakers, with repre'ientativE's from lewis serving as moderators. Proxy Talks are 

held prior to the publishing of research order to glean additional information for Glass Lewis' analysis 

and to provide more information for clients. For certain meetings, such as control contests, Glass LewIs 

will host separate Proxy Talks with both sides, i.e. management and the dissident s.hareholdeL 

Glass Lewis encourages corporate to contact Glass Lewis via the Issuer Engagement Portal. Gfass 

Lewis designed the Issuer Engagement Porta! to Jnd track communication with companies, 

including arranging calls, meetings and Proxy Talk conference caUs. The portal also provides a means for 

companies to comment and provide feedback on reports Jnd to notify Glass Lewis of subsequent proxy 

circulars and press relea5cs, as weI! as perceived errors or omissions in Glass Lewis reports. 
427 


81762.390

Proxy Voting Policies and Procedures of World's largest Investors 

Global Asset Managers 

Amundi Asset Management: 

http://www.amundi.com/documents/doc download&file=5112628700767891702 5112628700761416 

322 

AXA Investment Managers: http://www.axa-im.com/en/responsible-investment/policies-exclusions 

BlackRock: http://www.blackrock.com/corporate(en-us(about-us/responsibIe-investment 

BNY Mellon: http://www.bnymellon.com/investmentmanagement/guidelines.html 

Capital Group: 

https://server.capgroup.com/capgroup/action/getContent/G I G / E u ro pefl n stitutio n 5/ About Ca pital/ Res 

ponsible investing/RI 

Deutsche Asset Management: https://www.dws-investments.com/EN/proxy-voting.jsp 

Fidelity Investments: 

http://pe rs on a I. fi de I ity. c9m /myfid el ity/I n si d e Fi delityj I nvestExpe rtise/P roxyVoti ng/P roxyVoti ngOve rvi e 

w.shtml 

Franklin Templeton Investments: 

https://www.franklintempleton.com/reta ii/pages/gene ric content/home/proxy/proxy voti ng. jsf 

Goldman Sachs Asset Management: 

http://www.goldmansachs.com/gsam/pdfs/voting proxy policy.pdf 

JP Morgan Asset Management: 

https://www.jpmorganfunds.com/cm/Satellite?UserFriendlyURL=proxyguidelines&pagename=jpmNani 

tyWrapper 

Northern Trust: http://www.northerninstitutionalfunds.com/resources/docs/nt proxypolicy.pdf 

PIMCO: http://investments.pimco.com/Pages/PIMCOProxyPoiiciesVotingRecords.aspx 

Prudential Investments: http://livermore.brand.edgaronline .com/E FX diI/EDGARpro. d II? FetchFiI i ngHtmlSectionl ?Section I D=67 22960-522018-

526173&SessionID=aruSHWvshMTQ6A7 
428 


81762.391

State Street Global Advisors 

http://www.gefunds.com/common/docs/pdf/proxy/ProxyVotingPolicies-SSgA.pdf 

Vanguard: https:/linvestor.vanguard.com/about/vanguards-proxv-voting-guidelines 

Global Pension Funds 

Government Pension Fund (Norway): 

http://www.nbim.no/Global/Documents/Governance/Policies/NBIM%20Policy%20RI.pdf 

ASP (Netherlands): 

http:f(www.apg.nl/apgsite/pages/images/Corporate%20Governance%20Framework%202011%20ENG% 

20DEF tcm124-130303.pdf 

California Public Employees Retirement System (U.S.): http://www.calpers·governance.org/docssof /principles/2011-11-14-gl obal-pri nci ples-of-accountable-corp-gov. pdf 

Canada Pension Plan (Canada): 

http://www.cppib.ca/files/Legal Policies/2013/Proxy Voting Principles and Guidelines.pdf 

Employees Provident Fund (Malaysia): 

http://www.kwsp.gov.my/pv obi cache/pv obi id 617CF2816B40D623EllFF6255E0C75D54E722400/f 

ilename/BI EPF%27S%20Corporate%20Governance%20Principles%20And%20Voting%20Guidelines.pdf 

PFZW (Netherlands): http://www.pfzw.nl/about-us/Documents/responsible-investment-annual-report2011.pdf 

California State Teachers Retirement System (U.S.): http://www.calstrs.com/sites!main!files!fileattachments!corporate governance principles l.pdf 

New York State Common Retirement Fund (U.S.): 

http://www.osc.state.ny.us!pension!proxyvotingguidelines.pdf 

New York City Pension Funds (U.S.): 

http:f(www.comptroller.QYf~LPureA.~2L!:>am~p~QygLP.QfL2012-Shargholder-Report.pdf 

ATP (Denmark): 

http://www.atp.dk!X5!wps!wcm!connect!atp!atp.com!about!omatp/investments!corporate governan 

ce!policies!policies.htm 
429 


81762.392

May31,2012 

The Honorable Mary Schapiro 

Ch(1irman 

US Securities and Exchange Cornrnission 

100 F Street, NE 

Washington, DC 20549 

Dear Chairm;m Schapiro: 

G!ass, lewis & Co. ("G!ass lewis") 15 a leading, independent, governance analysis and proxy 

voting firm, servlng institutional investors globally that collectively manage more than $15 

triflion in assets. With research focused on the long-term impact of proxy votjng decisions! 

GJass lewis provides institutional investors with the resedl"ch, data and tools that help them make 

sound voting decisions by uncovf:rlng and assessing govemanCf:-:, business, legal, political and 

accounting risks at public companies worldwide. 

We understand that on May 30, 2012, the Center for Capital Morkets Competitiveness 

(,,[[MC") of the u.s, Chamber at Commerce submitted letter to you regarding the activities of 

G!ass Lewis in relation to particular proxy voting matter, The fo!!owing response seeks to 

clarify how Glass Lewis makes its voting recommendations, and, in partlcular, to refute the 

suggestion that Glass lewis' voting recommendations are somehow influenced by its parent's 

interests as an investor. 

Background 

Since 2007, Glass Lewis has been a wholly-owned subsidtary af Ontario Teachers' Pension Plan 

("OTPP"), which manages $117 billion (Canadian) as a fiduciary on behalf of 300,000 current 

and retired tea{hf~rS in Ontario, O! PP is subject to the Pension Benefits Act (Ontario) wh1ch sets 

forth fiduciary duties for all pension plan administrators in Ontario and obliges them to 

Jdminister the plan and invest assets with the prudence expected of [] person dealing 

with another's property. The stlJndJrds of conduct expected of a fiduciary are also set out 1n 

common law to which OTPP is subject, Consistent with these fiduciary responsibilitic5, OTPP 

votes accordrng to own proxy voting polkies {which, along with OTPP's proxy votes, are 

publicly-available here: 

bl!Qjj'j>l'ljw,otpp,comIWQ~m!connectLQlp~nLJjQLD5'l&:IfJQ_nsibie+lnvesting!Governancc! 

OTPP is the owner of Glass Lewis, not its operator; and as an owner with a !ong~term horizon, 

OTPP ]s committed to ensuring Glass lewis continues an independent advisor that puts the 

interests of its clients ahead of all others. 
430 


81762.393

Conflict Management 

Glass Lewis prides itself on avoiding conf!lcts of interest to the maximum extent possible. As a 

result, Glass lewis. does not enter into business relationships that conflict with its mission of 

serving institutional participants In the capita! markets with objectiv€' advice and services, 

G!ass lewis takes precautions to ensure its research is objective at all times and under all 

circumstances. As an indirect wholly-owned subsidiary of OTPP, Glass lewis maintains Its 

independence and operates completely separate from OTPP. OTPP is not Invo!ved in the dayto-day management of Glass lewis and is excluded from any involvement in how Glass Lewis 

formulates voting recommendations. The proxy voting and related corporate governance 

policies of Glass Lewis enforce that separation froin OTPP. 

As part of Glass Lewis' continued commitment to its tustom€rs~ Glass lewis has an 

independent Research Advisory Council {"CouncW'j. The Council ensures that G!ass lewis' 

research consistently meets the quality standards, objectivity and independence criteria set by 

Glass Lewis' research team leaders. The Council, chaired by Charles A. Bowsher, former 

Comptroller Genera! of the United Statesl and supported by Robert McCormick, Glass lewis' 

Chief Policy Off1cer, includes the foHowinr; experts In the fields of corporate governance, 

financE, law, management and accounting: Kevin 1 Cameron, co~founder and former President 

of Glass, Lewis & Co.; Jesse Fried, Professor of law at Harvard law Schoo!; Bengt Ha!!qvist, 

Founder of the Brazilian Institute for Corporate Governance; David Nierenberg, President of 

Nierenberg Investment Management Company; and Ned Regan, Professor, Baruch Co!!€ge. 

Glass Lewis does not offer consulting services to public corporations or directors. Glass lewis 

is not in the business ot advising public companies on their governance structures or conduct, 

and does not use its position as trusted advisor to institutional investors to win consulting 

mandates wjth issuers, In certain instances, Glass Lewis may provide its research reports to 

investment managers that may be affiJlated with pub]jdy¥hetd companies. In such cases, 

however, Glass Lewi'5 discloses any such relationship on the relevant research report. 

Moreover, Glass. lewis makes its rEsearch reports generally available post-publication. 

Furthermore, Glass lewis maintains additional conffict avoidance safeguards to mitigate 

potential conflicts. These apply when: (i) In employee of Glass Lewis or any of its subsidiariesl 

a member of the Council, or member of Glass lewis' Strategic Committee serves as: an 

executive or director of a public company; (ii) an investment manager customer is a public 

company or a division of a public company; (Hi} a Giass lewis customer submits (l5harenolder 

proposal or is a dissident shareholder in a proxy contest; and flv) when Gluss Lewis provides 

coverage on a company in which OTPP holds a stake significant enough to have pubHcly 

disclosed its ownership in accordance with the local market's regul<ltory requirements; or Glass 

Lewis becomes aware of OTPP's disclosure to the public of its ownership stake in such company 

LLC 
431 


81762.394

through OTPP's pub1ished annua! report or any other pubHcly ,'wailable information disdosed by 

OTPP. 

10 each of the instances described (]bov€, Glass Lew1s makes ful! and prominent disclosure to its 

customers on the cover of the relevant research report. !n the case of the MJY 17, 2012 

contested election at Canadian Pacific Railway Limited ("Cpn), which features prominently in 

(CMe's letter, Glass Lewis provided the following disclosure on the front of its report: 

"It is Glass Lewis' policy to make full disclosure to its customers In instances whNe Glass 

Lewis provides coverage on a company in which Ontario Teachers' Pension Plan Board 

{"OTPP''}, Glass Lew!s' ultimate parent, holds stake s!gnlficant enDugh to have publlcly 

announced its ownership in accordance with the local market's regulatory requirements 

or Glass Lewis becomes aware ot OTPP's disclosure to the pub!!c of its ownership stake 

in such company, through OTPP's published annual report or any other publicly 

available information disclosed by OTPP. 

In accordance with such polley, please be advised that OTPP held an owner<;hjp stake in 

the Company as at December 31,2011. OTPP is not involved in the day· to-day 

management of Glass Lewis. G!ass Lewis operates and will continue to operate as an 

independent company sepJrate from OTPP. The proxy voting and related corporate 

governance policies of Glass Lewis are 5eparat(~ from OTPP. OTPP is not a member of 

G!ass lewis' Research Advisory Council. 

For a complete copy af Glass Lewis' Conflict of Interest St(lte-ment, p!eilse visit 

.tl~~?il~1~:i52.!Dl~Q!'npdnYLglg;lQsun~~l2b12/' 

A copy of the complete research report for CP included with this letter. 

Research Process 

Glass lc~w!s research professionals analyze public company filings, specificGl!y proxy statements 

and financial statements, (IS we!1 multiple extern a! original research sources to evaluate 

board effectiveness and company risk profHes< 

G!ass lewis strongly believes its analysis, research and recommendations should be based on 

publicly avai!able information and encourages companies provide comprehensive and dear 

disclosure about the relevant issues for consideration by shareholders, For this reason, Glass 

Lewis often engages in discussions with companies outside the proxy season, but generally 

dm:5 not engage in discussions with companies during the proxy solicitation period. in the case 

of contested meetings, Glass Lewis will occasionally engage in separate discussions with both 

sides, usually in the form of a Proxy Ta!k conference call, In the case of CP, Glass lewis met with 
432 


81762.395

both representJtives of the Company and the dissident shareholder. All of these dlscussions 

were confined to a review of materia!", already in the public domain. 

In its May 30 letter, ((Me asserts that the timing of the Glass lewis report publication, 

subsequent to the announcement by OTPP of its vote dedsions on the CP meeting, is indicative 

that the Glass Lewis recommendation was somehow influenced by OTPP's vote dE:'cision. 

However, you should know that OTPP, as a matter of policy, publishes its voting intentions as 

soon as OTPP has voted, in advance of a shareholder meeting. 

For its part, Glass Lewis normally publishes its repDrts on annual genera! meetings at U.S. and 

Canadian companies about three weeks prior to meeting date. !n cases where OTPP is 

shareholder, this u:sually would precede OTPP's announcement of its voting intentions. 

However, there is no effort on Glass lewis' or OTPP's part to coordinate the timing of these 

events, and any such coordination would in fact contravene the separation enforced by Glass 

Lewis' policies. When there is proxy contest, where the situation is more fluId due to potentia! 

negotiations and additional disdosure by both parties, Glass Lewis often publishes its reports 

dose to the meeting date as attempts to balance the need t{) give clients sufficient time to 

review and digest our analysis With the need to ensure that clients have the complete, up-todate analysis to support their informed deciSion-making" Often companies make concessions in 

the face of potent!ally lOSing a proxy contest as the meeting date approaches, which was the 

case a.t CP. The date of pub!1cation of GIClSS lewis' report on CP also was affected by the timing 

of the previously mentioned meetings with the dissident and the Company and the need to 

complete the analysis after the conclusion of those meetings. 

In (CMe's May 30 letter, ((Me cited an article that appeared in the WaN Street Journal On fine 

regarding Glass LeWIS' voting recommendatjons in regards to CP. In that very article, the author 

noted) contrary to CCMe's assertions, that "Ontario Teachers owns Glass Lewis, but they make 

corporate governance decisjon'> independent of each other." !n fact, that is precisely what 

happened in this Case, where OTrp voted against of the Incumbent directors, whereas Glass 

Lewis recommended supporting seven of the Company nominees. 

There have been numerous other instances where Glass lewis recommended that its clients 

vote in a manner that differed from OTPP's votes. Notab!y, in 2011 Glass Lewis recommended 

in favor of the offer by the London Stock Exchange (LSE: LSE) to purchase to the TMX Group Inc 

(T5X: X), which owns and operates the Toronto Stock Exchange and TSX Venture Exchange, 

whereas OTPP and other Canadian investors were prominent and pubHc opponents ofthc 

transaction, before and after the publication of Glass LeWIS' analYSIS. This year Glass lewis 

recommended against two directors Magna !nternational Inc. (TSX: MG), whercas OTPP 

voted against all the directors that had been at the company since 2010. And, in 2010, OTPP 
433 


81762.396

publicly came out against the chairman and deputy chairman at Vodalane (LSE: VOO), both 01 

whom Glass Lewis supportecL 

Transparency 

Glass Lewis' publlc website (YiWw,glass!t:wls.com) features an Issuer Engagement Port(]L 

through whkh issuers (un down!oJd subst,mt!a! information regarding G!ass Lewis' policies and 

procedures, including details on the approaches used for the anJ!ysis of director elections, 

compensation plans) mergers & acquisitions and contested meetings, among other issues. This 

information is available by cOcking on "Issuers" in the top navigation. Glass Lewis' Conflict of 

Interest Statement is also available on the website at h!.1Q1Lwww.gjass!ewis.com!about~glas5-

iewis/discio5ure-of-conf!ifU and Conflict Avoidance Procedures ure available upon request, 

As outlined in Gluss Lewis' comment letter regarding the S.E.C. Concept Release on the u.s. Proxy System issued in 2010 (File Number 57 .. 14-10) and reiterated here, Glass leWIS maintains 

robust conflict avoidance and disclosure policies. Indeed, since the Issuance of the release, 

Glass lewis has dramatically enhanced its transparency with the development of the Issuer 

Engagement Portal. Furthermore, Glass Lewis is accountable to its clients, who use its research 

to mnke informed proxy voting decisions and hJve the option to use other provider{s) if they 

perceive the research to be conflicted or flawed. 

Glass Lewis appreciates the opportunity to respond to the ((Me letter and is confident that an 

objective consideration of this malter demonstrCltes that Glass Lewis makes proxy voting 

recommendations free from conflicts of interest and In an open and transparrnt manner. 

51ncerc::ly, 

Is! 

Katherine H. Rabin 

Chief Executive Officer 

cc: Elisse B. Walter, Commissioner, Securities and Exchange Commission 

L.uis A. Aguilar, CommissIoner, Securities Jnd Exchange CommiSSion 

Troy A. Paredes, CommisSioner, Securities zlIld ExchQng(~ Cornrnission 

Danie! M. Gallagher, Commissioner, Securities and Exchange Commission 

Ene. 

()